Q3 Canadian GDP Growth Slowed On The Back of Weak Housing and Business Investment

However, while the headline growth of 2.0% was on trend, the details of the report are troubling. The bulk of the growth last quarter came from a contraction in imports–hardly a sign of a robust economy–leaving final domestic demand–which excludes trade–negative for the first time since early 2016. The softness in imports reflected a contraction in refined energy products as well as aircraft and other transportation equipment.

The NAFTA trade battle over the summer took its toll on the economy as households and businesses sharply curtailed their spending. Consumer spending grew at its slowest pace in more than two years, while businesses posted an unexpected drop in investment and trimmed inventories. Consumer spending moderated, as overall household consumption rose just 1.2%, held back by durable goods spending (-2.7%) as Canadians bought fewer vehicles for a third straight quarter.

The biggest surprise in the report was the sharp decline in non-residential business investment (-7.1%). Spending on non-residential structures fell 5.2%, while machinery and equipment spending, which includes computer software and hardware, plunged at a 9.8% annual rate. Business spending was weighed down by softer oil and gas investment.

Though residential investment was expected to decline, the reported 5.9% drop in Q3 was more significant than expected. Despite an uptick in home sales activity, residential investment weakened as both new construction of housing and renovation activity pulled back (see Note below). Investment in new residential construction posted its largest decline since the second quarter of 2009 when the financial crisis was hammering the global economy. The uptick in home sales was reflected in a sharp uptick in ownership transfer costs, which includes real estate commissions, land transfer taxes, legal fees and file review costs (inspection and surveying).

On the income side, compensation of employees rose 2.7% (4.0% on a year-on-year basis), leaving overall wage gains over the quarter at a modest 2.2% year-on-year. The household savings rate rose to 4.0% from an upwardly revised 3.4% in Q1.

Looking at the monthly data for September, there was not much momentum going into the final quarter of this year. Monthly GDP in September declined -0.1% as just half of major industries expanded. It was mainly down in goods production (-0.7%) as oil and gas extraction pulled back, hit in part by maintenance work. Substantial gains in services (+0.2%) were not enough to keep the headline in positive territory.

The projected further weakening in Q4 will be abetted by the transitory downward impact from the recent postal strike. The risks are on the downside for the Bank of Canada’s forecast of 2.3% growth in the final quarter of this year. Currently, it appears that growth in Q4 will be closer to 1% than 2%.

Implications for the Bank of Canada

The headline 2% growth rate was spot on the Bank of Canada’s expectation, but certainly, the Bank will note the weakness in the underlying data. Potentially more important is the deep reduction in the price of oil for Canadian producers already struggling with transportation bottlenecks that have been pummelling the energy sector and depressing growth in Alberta. Cuts in oil production are likely to hit economic activity in the current quarter, with a full recovery not expected until at least mid-2019.

As well, the GM shutdown in Oshawa, Ontario raises concerns about the viability of the Canadian auto industry and adds to the weakness in the economic outlook. The two largest export sectors in Canada are energy and autos, so weakness in these sectors will keep the Bank of Canada on the sidelines in December, notably as consumers may well be tapped out. Markets had been expecting a rate hike in January, but the latest data suggest that the prospects of such a move have dropped significantly.

Notes:

*Housing investment in the GDP accounts is technically called “Gross fixed capital formation in residential structures”. It includes three major elements:

• new residential construction;
• renovations; and
• ownership transfer costs.

New residential construction is the most significant component. Renovations to existing residential structures are the second largest element of housing investment. Ownership transfer costs include all costs associated with the transfer of a residential asset from one owner to another. These costs are as follows:

• real estate commissions;
• land transfer taxes;
• legal costs (fees paid to notaries, surveyors, experts, etc.); and
• file review costs (inspection and surveying).

Canadian Home Sales Weakened In October

Home transactions last month declined in more than half of all local markets, led by Hamilton-Burlington, Montreal and Edmonton. Although activity did improve modestly in many markets, it was offset by a decline in sales elsewhere by a factor of two. On a year-over-year (y/y) basis, sales were down in slightly more than half of all local markets as lower sales in Greater Vancouver and the Fraser Valley more than offset the rise in sales in the Greater Toronto Area (GTA) and Montreal by a wide margin.

New Listings

The number of newly listed homes edged down 1.1% between September and October, led by the GTA, Calgary and Victoria. The decline in new supply among these markets more than offset an increase in new supply in Edmonton and Greater Vancouver.

As for the balance between sales and listings, the national sales-to-new listings ratio in October came in at 54.2% — close to September’s reading of 54.4% and its long-term average of 53.4%. Based on a comparison of the sales-to-new listings ratio with the long-term average, about two-thirds of all local markets were in balanced market territory in October 2018.

There were 5.3 months of unsold inventory on a national basis at the end of October 2018. While this remains in line with its long-term national average, the number of months of inventory is well above its long-term average in the Prairie provinces and in Newfoundland & Labrador, where downward pressure on home prices is likely to continue. By contrast, Ontario and Prince Edward Island are the two provinces where the measure remains more than one standard deviation below its long-term average pointing to stable prices or modest gains. In other provinces, the number of months of inventory is closer to its long-term average and suggests that sales and inventory are well balanced.

Home Prices

The Aggregate Composite MLS® Home Price Index (MLS® HPI) was up 2.3% y/y in October 2018 with similar gains posted in each of the three previous months.

Following a well-established pattern, condo apartment units posted the largest y/y price gains in October (+7.4%), followed by townhouse/row units (+3.9%). By comparison, one-storey single-family homes posted a modest increase (+0.6%) while two-storey single-family home prices held steady.

Trends continue to vary widely among the 17 housing markets tracked by the MLS® HPI. In British Columbia, home price gains have been diminishing on a y/y basis (Greater Vancouver: +1%; Fraser Valley: +6.8%; Victoria +8.5%; elsewhere on Vancouver Island: +11.8%). Vancouver’s market balance is the weakest in almost six years, and prices for both condos and single-detached homes are now falling outright (the former were previously sturdy).

By contrast, MLS® HPI benchmark price comparisons are improving on a y/y basis among housing markets in the Greater Golden Horseshoe (GGH) region of Ontario that are tracked by the index. Home prices were up from year-ago levels in Guelph (+9.3%), Hamilton-Burlington (+6.8%), the Niagara Region (+6.3%), the GTA (+2.6%) and Oakville-Milton (+2.2%). While home prices in Barrie and District remain slightly below year-ago levels (-0.9%), declines there are shrinking; if current price momentum persists, home prices in December are on track to turn positive compared to December 2017.

Across the Prairies, benchmark home prices remained below year-ago levels in Calgary (-2.6%), Edmonton (-2.4%), Regina (-3.6%) and Saskatoon (-0.9%).

Home prices rose by 6.6% y/y in Ottawa (led by a 7.4% increase in two-storey single-family home prices), by 6.3% in Greater Montreal (driven by a 9.8% increase in townhouse/row unit prices) and by 4.2% in Greater Moncton (led by a 12.4% increase in townhouse/row unit prices) (see table below).

Bottom Line

Housing markets continue to adjust to regulatory and government tightening as well as to higher mortgage rates. The speculative frenzy has cooled, and multiple bidding situations are no longer commonplace in Toronto and surrounding areas. The housing markets in the GGH appear to have bottomed. However, prices still look soggy at the higher end of the single-family home market.

The slowdown in housing markets in the Lower Mainland of BC accelerated last month as the sector continues to reverberate from provincial actions to dampen activity, as well as the broader regulatory changes and higher interest rates.

We are likely in store for a prolonged period of modest housing gains in the Greater Golden Horseshoe, stability or softening in British Columbia and further weakening in the Prairies, Albert, and Newfoundland & Labrador.

Montreal and Ottawa remain the areas of relative strength among the biggest cities. Sales dipped in both cities month-over-month in October, but they are both up a solid 11% from a year ago. In Montreal, we’ve seen some evidence that increased foreign buying activity is mixing with strong domestic fundamentals, pushing benchmark prices up 6.3% y/y. Ottawa has been boosted by a wave a federal government spending and hiring, with price growth similarly running at 6.6% y/y, though now softening from its recent high.

The Bank of Canada is expected to continue gradually tightening monetary policy. Residential mortgage credit growth has slowed to a 17-year low and, for the first time in a decade, borrowers will be refinancing 5-year fixed rate mortgages at higher interest rates.

Bank Of Canada Reports Dramatic Drop in Highly Indebted Borrowers

In a separate report, the Bank of Canada announced this week that the quality of new mortgage lending in Canada had improved markedly owing to tighter mortgage qualification rules and higher interest rates, both of which have pushed marginal buyers out of the market. This was Ottawa’s intention all along in its multiple initiatives to dampen the housing market over the past several years.

The share of new mortgages going to highly indebted borrowers–those with loan-to-income ratios of above 450%–dropped to 13% in the second quarter of this year, down from more than 18% last year. Hence, the Bank believes that there is strengthening resiliency in the financial system, aided in part by an improving economy that has prompted five rate increases since the middle of last year.

The Bank of Canada report on the mortgage market found that not only are the number of new mortgage borrowers declining, but the riskiest ones are being weeded out. The number of new uninsured borrowers considered highly-indebted fell by 39% in the second quarter from year-ago levels, with Toronto posting the most significant declines.

The Bank also commented that the tighter regulations have had one side effect–shifting market share away from the country’s six biggest banks to other institutions such as credit unions and private lenders, which they see as a potential new source of risk. The overall riskiness of new mortgages has decreased “because the proportion of risky borrowers has declined across cities,” the report found. “As well, the regional composition has shifted, with a somewhat larger share of new mortgages recently coming from areas outside Toronto and Vancouver.”