Grimmer fairy tales: The ‘Three Bears’ of Canada’s economy

Briefing highlights

The economy’s ‘Three Bears’
Stocks, loonie, oil at a glance
Toronto home sales fall in February
China trims GDP target
Target gains on forecast
From today’s Globe and Mail

Grimmer fairy tales

Canada's economy is sputtering, weighed down by what economist Robert Kavcic refers to as its "Three Bears": Housing, business investment and consumer spending.

That spells trouble for the current quarter of the year, after what was almost flat-lining growth in the final three months of 2018, and promises to figure prominently in the Bank of Canada’s rate decision Wednesday.

But the second quarter could well be better. And regardless, we could still see a Goldilocks stock market if the Federal Reserve is comfortable with the not-too-hot-not-too-cold thing.

“The equity market seems to have written off much of the [U.S.] weakness and is already looking ahead to more trend-like growth in Q2 through Q4,” said Mr. Kavcic, senior economist at Bank of Montreal.

"That might be Goldilocks if the Fed sits on its hands and inflation remains well contained," he added.

"In Canada, it’s more like the Three Bears, with housing, business investment and weaker consumer spending all weighing heavily on Q4 growth."

Gross domestic product expanded in the fourth quarter at an annual pace of just 0.4 per cent, with the economy actually contracting mildly in December alone.

“A weak December handoff, along with Alberta’s mandated production cuts and ongoing weakness in the Toronto and Vancouver housing markets, suggests Q1 will do well to grow at all - we cut that forecast, too, to zero,” Mr. Kavcic said.

"At any rate, while the Fed will be patient, the Bank of Canada will need a pretty dramatic turnaround to raise rates at all later this year."

Indeed, expect Bank of Canada governor Stephen Poloz, senior deputy governor Carolyn Wilkins and their colleagues to hold their benchmark overnight rate at 1.75 per cent Wednesday and issue a downbeat accompanying statement.

Here's a look at Mr. Kavcic's bears:

Residential investment

Most Canadian housing markets appear to be stabilizing after being hit by rising interest rates and new mortgage-qualification stress tests, known as B-20 rules, which were aimed at deflating a housing-related bubble.

Those pressures helped push housing down by an annualized 14.7 per cent in the fourth quarter.

“Sales were hit hard in 2018 due to the B-20 rules and rising rates, and there’s some concern that the drop in activity could worsen,” said Benjamin Reitzes, Mr. Kavcic’s colleague and BMO’s Canadian rates and macro strategist.

"The early 2019 housing data have been decent enough, but the bank will want to see more evidence before these concerns are dampened. It will need at least another few months of data and a look at the spring season.

Business investment

Keep in mind that the central bank has been hoping that such investment and stronger exports would help shift economic support away from housing and reliance on consumers.

That’s not happening, with such spending falling almost 11 per cent in the final three months of 2018.

"Another issue likely to be highlighted [by the Bank of Canada] is the extreme weakness in business investment through the second half of last year," Mr. Reitzes said.

"The BoC was banking on investment and exports taking the growth reins, but that’s hardly been the case. In January, the BoC was still somewhat upbeat on the economic backdrop, but the tone is going to be a bit more cautious."

Consumer spending

Canadians, of course, have already had to juggle their budgets to account for the central bank's earlier rate hikes.

Now, said Sébastien Lavoie, chief economist at Laurentian Bank Securities, "there is a clear sign of household spending fatigue.

He drove home that point by citing Friday’s report showing household consumption rose in the fourth quarter at just 0.7 per cent, its “weakest pace” since the financial crisis.

"Given the weight of household spending in the overall economy, its sharp slowdown was particularly troubling," added Toronto-Dominion Bank economist Rishi Sondhi.

Working in the economy's favour, is a still-strong jobs market, and we'll get the latest measure of that on Friday.

But when you put together all the signs of last week, Mr. Sondhi said, they “send the message that past rate hikes have been more dampening than expected, perhaps lessening the need for future increases, or, at a minimum, reinforcing the need for patience.”

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Home sales fall

Toronto home sales slipped 2.4 per cent in February from a year earlier, prompting local realtors to urge the federal government for measures to aid the market.

As The Globe and Mail’s Janet McFarland reports, the Toronto Real Estate Board said today the federal bank regulator should review the mortgage-qualification stress test brought in early last year and Finance Minister Bill Morneau should consider bringing back 30-year amortizations for insured mortgages in his March 19 budget.

The group also reported average prices for all home types rose 1.6 per cent from a year ago, pushed up primarily by condos.

The average price of a detached home declined 2.1 per cent.

“Keep in mind, though, that the weather was pretty bad in what is already a low-volume month, so I wouldn’t read too much into it,” said BMO’s Mr. Kavcic said of the February results.

“The overall market balance is still soggy, and price growth looks to have decelerated again, with condos looking relatively firm,” he added.

“It’s interesting that TREB is openly calling for policy changes in their data release - could mean that members on the ground are seeing soft conditions without much improvement. Things could look a bit firmer once the snow melts, especially with 5-year bond yields down almost 70 basis points from their 2018 highs.”

China cuts target

China has trimmed its economic growth target for the year to between 6 and 6.5 per cent, but some analysts expect something less.

That target, unveiled at the National People’s Congress today, compares to about 6.5 per cent in 2018.

“Officials pledged some moderate policy easing this year but still appear reluctant to allow a sharp rebound in lending, even if this comes at the cost of slower growth,” said Julian Evans-Pritchard, senior China economist at Capital Economics, and his colleague, China economist Chang Liu.

“With headwinds likely to remain strong over the coming months, we expect the economy to slow until the second half of this year, averaging 4.5 per cent over 2019 as a whole,” they added.

“Our forecasts for growth to stabilize later this year assume that some further policy support is forthcoming.”

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