Economy more reliant than ever on housing

One of the most striking developments since the pandemic has been the surge in residential investment. The fourth-quarter national accounts, which this week showed a stronger-than-expected 9.7% annualised gain in GDP (see here), also revealed that residential investment jumped by 18% annualised. That left it 14% higher than a year ago.

Residential investment now accounts for a striking 9.3% of GDP – up by 2%-points in the past year and far higher than the long-run average. (See Chart 1.)

Chart 1: Residential Investment (% of Nominal GDP)

Source: Refinitiv

With the Bank of Canada meeting next week and forecasters increasingly focused on whether it might soon become more hawkish (see our Bank of Canada Watch), this raises an interesting question; is the surge in residential investment a sign of “froth” that justifies tighter policy, or is it a warning that higher interest rates could quickly topple the still fragile recovery?

Slightly more than half of the jump in residential investment in the past year has been due to increased home improvements and new construction. That reflects people spending more time at home and desiring more spacious homes. It would be a huge stretch to suggest that this spending is a sign that tighter policy is needed.

The desirability of the surge in home sales, which explains 45% of the annual jump in residential investment, is more debatable. We are well past the point where we could claim that the elevated level of sales is catch-up growth from the weak start to 2020. With the 12-month average of sales now at a record high (see Chart 2), and house price inflation almost 10%, some commentators are sounding the alarm.

Chart 2: Monthly Home Sales (000s)

Source: CREA

Even here, however, the situation is uncertain. It is not unreasonable to think that, following an event that has perhaps permanently changed the way we live and work, sales should be higher than normal as people adjust. The rise in prices is still in line with what we might have expected given the slump in mortgage rates and could go further if increased working from home means buyers are willing to commit more of their income to mortgage payments.

Ultimately, residential investment is one of the most sensitive sectors of the economy to changes in interest rates, and the Bank seems unlikely to jeopardise its current strength while activity elsewhere remains weak. Governor Tiff Macklem recently said that the Bank would only become concerned about the housing market if consumers’ expectations for house price growth started to rise sharply, as this could risk triggering an unsustainable boom that takes house prices far above their current levels. We will therefore need to pay particularly close attention to the Bank’s forthcoming Survey of Consumer Expectations, released in April.

The week ahead

Following the Bank’s meeting on Wednesday, we will be holding a drop-in conversation to discuss the decision and unpack the policy statement. (You can register here for the session, which begins at 12:00 EST). At the end of the week, we expect to learn that employment rebounded by 160,000 in February.

Data Preview – Labour Force Survey (Feb.) 08.30 Fri. 12^th Mar.

A partial rebound

We estimate that employment rebounded by 160,000 in February as the coronavirus restrictions were eased.

The restrictions imposed across Ontario, Quebec and Alberta caused a combined 266,000 of job losses in December and January. We expect those losses to have been partially reversed in February as the easing were gradually eased. For example, growth in restaurant visits picked up from -80% to -55% over the course of the month, and much of that improvement should be reflected in the LFS given the reference week is relatively late in the month. Other services employment, especially retail, should also rebound as non-essential stores re-opened. Altogether, we are assuming a 160,000 increase, which would pull the unemployment rate back down to 9%.

Encouragingly, the Indeed.ca job listings data have now returned to their pre-pandemic level and new listings rose further at the end of February, which points to another decent gain in employment this month. (See Chart 3.)

Chart 3: Indeed.ca Job Listings

Source: OpenTable, Capital Economics

Economic Diary & Forecasts

Stephen Brown, Senior Canada Economist, +1 416 874 0514, stephen.brown@capitaleconomics.com