Dodging Bubble Means Canada Economy Loses EdgeTheophilos Argitis
Canadian Finance Minister Jim Flaherty’s efforts to avert a housing bubble are hastening the end of a six-year streak of outperforming the U.S. economy.
Changes implemented yesterday include shortening the maximum length of government-insured mortgages to 25 years from 30 years to quell demand for new homes and curb record household borrowing that Flaherty said has become a greater risk to the economy than slowing growth.
The rule changes make it harder for some buyers to qualify for mortgages. Ebbing demand for homes removes one more driver from the world’s 10th largest economy, said Douglas Porter, deputy chief economist at Bank of Montreal. Residential construction was the fastest expanding segment in the first quarter, responsible for almost half of Canada’s 1.9 percent growth as consumer and government spending slowed.
“Basically the consumer is all tapped out, the housing market has no room to grow, we’re seeing fiscal restraint,” Porter said. “It’s very difficult to imagine Canada outpacing the U.S. economy in growth terms.”
Canada’s economy is projected to grow by 2.1 percent this year, according to economists surveyed by Bloomberg, down from a pace of 2.4 percent in 2011 and 3.2 percent in 2010. U.S. growth will accelerate to 2.2 percent from 1.7 percent last year, economists project, marking the first time since 2005 Canada has lagged its biggest trading partner. Canada’s average growth of 0.9 percent since 2008 topped the Group of Seven.
The new mortgage rules, coupled with steps taken by the country’s banking regulator to tighten mortgage lending standards, have the same impact in the real estate market as a 1.5 to 2 percentage-point increase in interest rates, David Tulk, chief Canada macro strategist at TD Securities in Toronto, estimated. The changes will reduce growth by 0.1 percentage points this year and 0.2 points in 2013, Tulk said.
Slowing household spending will lessen the risks posed by an overreliance on household debt to the country’s banking system, which was judged the world’s soundest by Geneva-based World Economic Forum for four straight years. Moody’s Investors Service cited the changes as being positive for banks such as Canadian Imperial Bank of Commerce and Toronto-Dominion Bank.
Household debt relative to disposable income rose to a record 154.3 percent in the first quarter, with Canadian debt levels surpassing those in the U.S. and the U.K.
Canada relied on household spending and government stimulus to emerge from recession in 2009, with business spending and residential construction sustaining the recovery over the past two years. The G-7’s soundest fiscal record allowed Harper and his provincial counterparts to boost government spending to more than one-quarter of the economy for the first time in 15 years.
A financial system that didn’t experience bank failures continued to lend at historically low interest rates after the recession, lifting the stock of home mortgages to a record and boosting consumer spending as a share of output to the highest in decades.
The recovery allowed Prime Minister Stephen Harper to boast in his 2011 election campaign that Canada was the “closest thing the world has to an island of security and stability.” That election gave Canada’s Conservatives their first electoral majority since 1988.
The economy also made global investors take notice. The country received C$326 billion in net capital flows in the three years between 2009 and 2011, more than the previous 15 years combined, while the Canadian dollar gained 38 percent between March 2009 and July 2011 against its U.S. counterpart.
“I wouldn’t call it Canadian exceptionalism, I would say we had much better initial conditions,” said Ed Devlin, head of the Canadian portfolio management team at Pacific Investment Management Co., the world’s largest bond fund manager. The country also got “very good policy responses both from the monetary and fiscal side.”
There’s been less for Harper to boast about in 2012.
Canada’s benchmark stock index is underperforming U.S. equities for a second year after seven years of stronger gains, which BMO’s Porter said reflects in part expectations the country’s economy will lag, and the Canadian dollar has come down 7.5 percent from its 2011 highs.
Unlike previous recessions, Canada hasn’t been able to rely on a recovery in export markets to drive its expansion. Even after a 13 percent rise since the end of 2009, the volume of exports remains 6.9 percent below pre-recession highs. Imports in the first quarter were 3.1 percent above pre-recession highs.
Canadians had already been reining in their demand for debt even before the measures. Household credit in April rose 5.6 percent from a year earlier, the slowest pace in a decade, while personal expenditures grew 1.9 percent in the first quarter from a year earlier, the slowest since 2009.
Toronto realtors recorded a 5.4 percent decline in the sale of existing homes last month from a year earlier, while sales in Vancouver fell 28 percent, according to realtor data released last week.
Governments have also become a drag, with state spending dropping five straight quarters. Cracks in the country’s fiscal reputation are beginning to show, as Moody’s downgraded Ontario’s bonds in April.
Businesses, meanwhile, have shown to be much more risk-averse than the country’s households after they were squeezed by banks during the recession, said Gerry Price of Winnipeg-based E.H. Price Limited, which manufacturers air distribution systems for non-residential construction. Companies are wary of relying on debt financing, he said.
“We just prefer to be masters of our own destiny,” Price, the company’s president, said in a telephone interview. “It slows us down just a bit, but it’s probably worth it in the long run.”
The reticence comes even as banks have tightened credit over the past three months, according to the Bank of Canada’s quarterly business outlook survey.
Non-financial companies have reduced their debt-to-equity ratio to 0.887 percent in the first quarter, the lowest since at least 1988, Statistics Canada data show.
The news isn’t all bad for Canada’s economy. With government finances still the best in the G-7, the country won’t need as much austerity as others to rein in its deficits, according to IMF projections. Wages and employment continue to grow, supporting spending even as households take on less debt. Canadian employers have added 155,500 jobs since February and earnings are growing at the fastest pace in almost three years.
Flaherty’s latest attempt to cool the country’s surging housing market may prove ineffective unless interest rates rise. Flaherty tightened mortgage rules three times before yesterday’s changes and in each case the market continued to grow. Canadian builders began construction on a seasonally adjusted annual pace of 222,700 homes in June, the Canada Mortgage & Housing Corp. said in a report today, compared with an average 197,650 over the past two years.
“Growth isn’t the be-all and end-all,” Porter said. A faster economy in the U.S. “doesn’t mean Canadian exceptionalism has completely gone away.”
Harper also is acting to speed up business investment, reducing regulatory hurdles for infrastructure projects and boosting outlays on research and development.
Spending on machinery and equipment and non-residential construction, while slowing, has increased by an average 12.5 percent over the past seven quarters and is up 28 percent since the end of 2009.
There also are some signs businesses are beginning to seek more financing. Business credit growth has averaged 5.4 percent over the past 12 months through May, compared with 3.2 percent the previous 12-month period.
Canada’s relatively balanced economy means risks are smaller than elsewhere, even if growth is tepid, according to Pimco’s Devlin.
“I like Canada’s composition of growth a heck of a lot better than the U.S., facing its fiscal situation,” said Devlin, who helps manage more than $11 billion in Canadian assets. “I like it better than Europe. I like it better than the U.K.”
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