Thursday, December 11, 2014

Commercial Real Estate Gains Momentum in BC

The BCREA Commercial Leading Indicator (CLI) rose 1.4 index points to a new record high of 118.4, surpassing the previous high of 117.1 set in the second quarter of 2014.

"Momentum has been building in sectors most important to commercial real estate,” said BCREA Economist Brendon Ogmundson, “That momentum should translate to a strong year for the commercial market in 2015."

The CLI has now advanced for seven consecutive quarters. That trend signals significant strength in the economic environment underlying the commercial real estate market.

A rising trend in the CLI generally points to growth in investment, leasing and other commercial real estate activity two to four quarters ahead.  Given the current trend, we would expect growth in the commercial real estate market for the remainder of 2014 and the first half of 2015.

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Canadian Housing Starts

New home construction in Canada rose 6.6 per cent in November to 195,620 units at a seasonally adjusted annual rate (SAAR).  The six-month trend in Canadian housing starts of 195,792 units SAAR was relatively unchanged and sits slightly in excess of Canadian household growth. 

Housing starts in BC urban centers increased 26.7 per cent on a monthly basis to 29,565 units SAAR.  On a year-over-year basis, housing starts were 10 per cent higher compared to November 2013. Single-detached starts were up 11 per cent while multiple units were up 10 per cent compared to this time last year. Year-to-date, total BC housing starts are 6 per cent higher than 2013. 

Looking at census metropolitan areas (CMA) in BC, total starts in the Vancouver CMA bounced back from a large decline in October, rising 10 per cent year-over-year on broad strength in both single detached and multiple starts. Year-to-date, Vancouver housing starts are up 3 per cent. In the Victoria CMA, new home construction fell 15 per cent year-over-year due to weaker starts of both single detached and multiple units. Year-to-date, housing starts in Victoria are down 16 per cent. Total housing starts in the Kelowna CMA were up 45 per cent year-over-year in November due to a large increase in starts of multiple units.  Year-to-date, housing starts in the Kelowna CMA are up 34 per cent . Housing starts in the Abbotsford-Mission CMA posted another steep decline in November, down 44 per cent year-over-year.  Year-to-date, new home construction in the Abbotsford-Mission CMA is down 28 per cent.

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Canadian and US Employment

Employment in Canada declined by 10,700 jobs in November after two months of large gains. The national unemployment rate ticked 0.1 points higher to 6.6 per cent. Total hours worked, which is closely associated with economic growth, rose just 0.1 per cent.

In BC, employment grew by 4,200 jobs in November. Both full-time and part time employment increased , and the provincial unemployment rate fell 0.3 points to 5.8 per cent. Year-to-date, total employment in BC is up just 0.7 per cent but has grown at an average annual rate of 1.6 per cent over the past 3 months.

The US economy added a robust 321,000 jobs in November while estimates of previous months job growth were revised higher by a combined 44,000 jobs. Over the past 3 month, US payroll growth has averaged a very healthy 278,000 jobs.  The US unemployment rate remained at 5.8 per cent.


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Mortgage Rate Outlook

• Mortgage rates remain at historic lows
• Canadian economy roars back in second quarter
• Poor job growth keeps Bank of Canada in neutral

 In stark contrast to the consensus of economists’ expectations at the end of last year, bond yields
have spent most of 2014 trending downward. Indeed, perhaps weary of previous false starts, bond markets have even shrugged off recent signs of a strengthening economy, an acceleration of inflation and the unwinding of stimulus from the US Federal Reserve. Lenders have responded in kind, offering homebuyers record low mortgage rates. 

Given well anchored inflation expectations and near consensus that short-term rates will be higher
next year, the continued downtrend in bond yields this year is difficult to explain. One factor could
be that investors are acclimating to the idea that the neutral rate, or the Bank of Canada’s preferred
destination for interest rates once it tightens, is likely much lower than in the past and that realization is being priced into expectations and therefore long-term interest rates.

Additionally, the performance of Canada’s financial and banking system post-financial crisis has won
it a reputation among foreign investors as a safe harbor. Foreign holdings of Canadian government
bonds and treasury bills have jumped from 15 per cent to over a quarter of outstanding debt since the global financial crisis. As uncertainty mounts in other areas of the world due to weak economic growth or unresolved conflicts, assets have crowded into both US and Canadian debt securities, forcing yields lower. Given these factors, rates could remain below historical average levels even as the Bank of Canada begins tightening.

While we do not expect the Bank to act on interest rates until late in 2015, bond yields could rise
modestly before then in anticipation of higher rates, particularly if economic growth is stronger
than expected. If so, we expect to see a slight increase in five-year and one-year fixed mortgage
rates by the end of 2014.

Economic Outlook

As was widely expected, the Canadian economy’s weak start to the year proved to be temporary as
growth roared back in the second quarter. Canadian real GDP expanded 3.1 per cent at an annual rate
last quarter, the highest rate of growth in close to three years. That growth was largely spurred by
exports to a similarly resurgent US economy, which grew at a robust 4.2 per cent annual rate in the
second quarter. If momentum in the US economy can be sustained, the long awaited rotation of
Canadian economic growth towards exports and business investment could be realized. Indeed,
in past business cycles, a recovery in business investment tends to lag behind a recovery in export

While we expect that economic growth will slow moderately from the robust pace of the second quarter, it will remain relatively strong at 2.3 per cent for 2014 before accelerating next year to 2.7 per cent.

CPI inflation, which has been above the Bank’s 2 per cent target for several months, is showing some signs of softening due to a sharp decline in the price of energy products and other commodities. Core inflation, which the Bank uses as its operational guide for monetary policy, has drifted higher but remains relatively muted. Though some wage inflation has occurred of late, slack in the labour market and continued competitive pressure in retail sectors will likely keep core inflation from breaching the Bank’s 2 per cent target in the short-term.

Interest Rate Outlook

While economic growth exceeded expectations in the second quarter, the economy looks far more
pedestrian if averaged over the entire first half of 2014. Employment growth has been uneven and the
Canadian unemployment rate remains stubbornly high. Given a weak labour market, the Bank of
Canada is unlikely to be moved from its current stance after just one strong quarter of economic
growth. We expect that the Bank will continue to take a cautious approach to monetary policy until
it sees concrete signs that the economy is growing sustainably above trend.

Our modelling exercises show the Canadian output gap closing along the same timeline as expected
by the Bank of Canada, with inflation returning to target in 2016. Therefore, while the Bank left the
door open to lower interest rates given its “neutral” stance, lags in monetary policy suggest a tightening of interest rates in the second half of 2015.

“Copyright British Columbia Real Estate Association. Reprinted with permission.”

Wednesday, December 3, 2014

Bank of Canada Interest Rate Announcement

The Bank of Canada announced this morning that it is holding its target overnight rate at one per cent. This marks the longest period without a change in the Bank’s policy rate since the 1950s. In the statement accompanying its decision, the Bank noted that inflation has been stronger than expected in the past year, though mainly due to temporary factors. The Bank also stated that slack in the Canadian economy appears to be lower than projected in October due to upward revisions to growth as well as a broadening Canadian economic recovery. The Bank cited falling oil prices and household financial imbalances as key risks to its outlook. 

Perhaps the most pressing development for the Canadian economy, and therefore monetary policy, is the recent downturn in oil prices. Untangling the macroeconomic consequences of declining oil prices can be complex for an oil-producing country like Canada. However, the recent decline in oil prices will likely be felt strongest on growth through decreased output in the oil and gas industry and on inflation through lower prices for energy products, particularly gasoline.  This suggests a delay in inflation returning to the Bank's 2 per cent target. We expect the Bank will begin slowly raising its overnight rate, starting late next year with perhaps a 25 basis point increase. That should translate to modestly higher mortgage rates in 2015. 

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