Construction prospects bright - Capital Economics
Canada Economics

Construction prospects bright

Canada Economics Weekly
Written by Stephen Brown

After a few months of weakness, the data this week showed increases in residential building permits and housing starts around the turn of the year. As new home sales in Toronto have now fully recovered from the weakness seen a year ago and building permits remain relatively strong, housing starts seem likely to remain above 200,000 for the first half of the year at least.

After a few months of weakness, the data this week showed increases in residential building permits and housing starts around the turn of the year. Building permits rose by 3.2% m/m to 227,000 annualised in December, while housing starts increased by 8.8% to 213,000 in January. The large rise in starts appears to have been partly due to the unseasonably mild weather in Ontario and Quebec in January, with strong gains in those provinces more than offsetting sharp falls in Alberta and British Colombia, where the winter weather was more severe than usual.

The outlook for housing starts in 2020 is healthier than we thought it would be. A year ago, we assumed the weakness of home sales would start to feed through to lower starts. To an extent that did happen, with the six-month average of starts now almost 10% below its peak. But with home sales rebounding strongly in the middle of 2019, it is hard to see much more weakness ahead.

Developers follow through on roughly 90% of the projects they get permits for, so the six-month average of building permits of 228,000 in December is consistent with starts averaging around 205,000 in the first half of the year. The recovery of new home sales in Toronto also bodes well for the outlook. As most new home sales in the city are now pre-construction condos, they tend to lead starts quite closely. The rebound in 2019 implies that starts in Toronto will rise to 40,000 annualised, from a monthly average of 30,000 over the past six months. (See Chart 1.)

Chart 1: Toronto New Home Sales & Housing Starts

Source: Refinitiv, Altus

Admittedly, the 2.9% m/m drop in sales of existing homes in January seems concerning. But that drop was mainly due to lower sales in those provinces affected by severe winter weather in January, while limited new supply kept a lid on sales in Toronto. Ultimately, the low level of new listings appears to be a sign that demand for new homes will remain buoyant. Developers should also benefit from higher prices – the sales-to-new listings ratio points to a sharp acceleration in house price inflation, from 2.0% according to the Teranet house price index in December to as high as 14%. (See Chart 2.)

Chart 2: Sales-to-New Listing Ratio & House Price Inflation

Source: Refinitiv , CREA

It seems unlikely that house price inflation will rise that far. The sales-to-new listing ratio moved in the opposite direction to house price inflation for a long period after 2018, which we suspect had something to do with the stricter mortgage regulations put in place at the start of that year. There is clearly evidence that house price inflation is increasing, however. The 3m/3m annualised change if the MLS price index was 5.4% in January and, if the recent monthly pace is maintained, the annual rate of house price inflation should also be above 5% by the second quarter.

The week ahead

There should be further evidence of higher house price gains next week, with the Teranet House Price Index for January likely to show a pick-up in house price inflation to 2.5%. Meanwhile, we expect to see that headline inflation edged up in January, while retail and manufacturing sales rose in December.


Data Preview – Manufacturing Sales (Dec.) 08.30 18th Feb.

Forecasts

Previous

Median

Capital Economics

Manufacturing Sales (%m/m)

-0.6%

+0.8%

Manufacturing sales rebounded

Following the disruption caused by the CN Rail strike in November, manufacturing sales probably rebounded in December.

After re-weighting the trade data to better-match the methodology of the manufacturing survey, our calculations suggest that manufacturing sales jumped by 1.5% m/m in December. (See Chart 3.) That said, the slump in manufacturing exports caused by the CN Rail strike in November did not weigh on sales as much as we had expected, so we doubt that the rise in manufacturing sales will be quite as high as the trade data seem to imply. We’re have pencilled in a smaller rise of +0.8% m/m.

The outlook for the sector remains challenging. Although the global business surveys have generally improved in recent months, they remain consistent with Canada’s non-energy exports declining, and Markit’s manufacturing PMI for Canada remains only just above 50.

Chart 3: Mfg Exports (CE-Adj.) & Mfg Sales (% m/m)

Source: Refinitiv, Capital Economics

Data Preview – Consumer Prices (Jan.) 08.30 19th Feb.

Forecasts

Previous

Median

Capital Economics

Consumer Prices (Jun)

0.0%(+2.2%)

+0.2%(+2.3%)

Core CPI Trim

(+2.1%)

(+2.0%)

Headline inflation to edge higher, core inflation to decline

We estimate that headline inflation edged up by 0.1%-point to 2.3% in January.

Admittedly, our calculations suggest that inflation in several categories declined in January. Energy inflation is likely to have edged down from December’s 5.5% and mortgage interest costs inflation is set to have fallen again following last year’s decrease in mortgage rates. Airfare inflation probably also dropped back following the boost during peak holiday period due to the current shortage of aircraft amid the grounding of the 737 Max jets. While those moves will weigh on the headline rate, we expect them to be more than offset by increases in inflation elsewhere, mainly due to base effects from weak price growth last January. We’ve therefore pencilled in a rise in headline inflation to 2.3%, from 2.2% in December.

By contrast, it seems likely that CPI-trim declined again. The m/m% change in CPI-trim last January was unusually high. That means if prices simply rise by their recent average this January, CPI-trim will decline by 0.1%-point to 2.0 %. (See Chart 4.) CPI-median is also likely to fall, to 2.1%, while we expect CPI-common to be unchanged at 2.0%.

Chart 4: CPI-trim

Source: Refinitiv, Capital Economics

Data Preview – Teranet/National Bank House Prices (Jan.) 08.30 20th Feb.

Forecasts

Previous

Median

Capital Economics

House Prices %m/m(%y/y)

+0.2%(+2.0%)

+0.7%(+2.5%)

House price inflation to rise further

We estimate that the Teranet index will show that house price inflation climbed to 2.5% in January.

House price inflation rose to 2.0% in December and it is likely to have increased further in January. It is one of the months where we already have the MLS house price index before the Teranet data. The MLS index showed a rise in house price inflation to 3.1%, from 1.7%. As the Teranet index takes a three-month average to smooth volatility, it is likely to show a smaller rise in house price inflation to 2.5%.

The city-level sales-to-new listing ratios point to higher house price inflation in most places. The turnaround in Vancouver has been particularly striking. The sales-to-new listing ratio there points to a return to house price inflation of 10%, from -4% in December. (See Chart 5.) With the number of homes under construction in Vancouver more elevated relative to demand than elsewhere, however, we doubt that such a strong pace would be maintained for long.

Chart 5: Vancouver House Prices and Sales-to-New Listing Ratio

Source: Refinitiv, CREA

Data Preview – Retail Sales (Dec.) 08.30 21st Feb.

Forecasts

Previous

Median

Capital Economics

Retail Sales (%m/m)

+0.9%

+0.3%

Core Retail Sales (%m/m)

+0.2%

+0.4%

A small rise

We suspect that retail sales edged up further in December, thanks in part due to the later timing of Cyber Monday in 2019.

November’s 0.9% m/m rise in retail sales is likely to have been followed by a smaller increase in December. We suspect that the weakness ins some categories in November, such as clothing sales which slumped by 1.7% m/m, reflected the later timing of Cyber Monday last year as it fell in December. If that theory is correct, there should be a bit of a boost to overall sales from rebounds in those categories. That is likely to have been offset by a decline in gasoline sales as a result of lower prices, while we suspect that auto sales were essentially unchanged. Accordingly, we’re pencilling in a rise in retail sales of 0.3% m/m and a rise in core retail sales of 0.4%.

The outlook for sales seems relatively bright, with the level of consumer confidence implying that annual retail sales growth should pick up to around 3%, from our estimate of 2.5% in December. (See Chart 6.) That said, with inflation near 2%, that would still imply real sales growth of just 0.5% or so.

Chart 6: Consumer Confidence & Retail Sales

Source: Refinitiv, Bloomberg


Economic Diary & Forecasts

Upcoming Events and Data Releases

Date

Release/Indicator/Event

Time EST (GMT-5)

Previous*

Median*

CE Forecasts*

Mon 17th

No Significant Data Released

Tue 18th

Manufacturing Sales (Dec)

08.30

-0.6%

+0.8%

+0.8%

Wed 19th

Consumer Prices (Jan)

08.30

0.0%(+2.2%)

+0.3%(+2.4%)

+0.2%(+2.3%)

Core CPI Common (Jan)

08.30

(+2.0%)

(+2.0%)

Core CPI Trim (Jan)

08.30

(+2.1%)

(+2.0%)

Core CPI Median (Jan)

08.30

(+2.2%)

(+2.1%)

Thu 20th

Teranet/National Bank House Prices (Jan)

08.30

+0.2%(+1.9%)

+0.7%(+2.5%)

Fri 21st

Retail Sales (Dec)

08.30

+0.9%

+0.2%

+0.3%

Core Retail Sales (Dec)

08.30

+0.2%

+0.3%

+0.4%

Selected future data releases and events

24th Feb

Wholesale Sales (Dec)

08.30

27th Feb

Current Account Balance (Q4)

08.30

28th Feb

GDP by Expenditure (Q4)

08.30

GDP by Industry (Dec)

08.30

Raw Material Prices (Jan)

08.30

*m/m(y/y) unless otherwise stated

Sources: Bloomberg, Capital Economics

Main Economic & Market Forecasts

%q/q ann. (%y/y) unless stated

Q4 2019

Q1 2020

Q2 2020

Q3 2020

Q4 2020

Q1 2021

2019

2020

2021

GDP

0.4

1.8

1.7

1.8

2.0

2.1

1.6

1.6

2.3

CPI Inflation

2.1

2.0

1.6

1.5

1.5

1.8

1.9

1.7

1.8

Unemployment Rate (%)

5.8

5.6

5.8

6.0

5.8

5.6

5.7

5.8

5.6

Overnight Rate, End Peri’d (%)

1.75

1.75

1.75

1.75

1.75

1.75

1.75

1.75

2.00

10 Yr GoC., End Period (%)

1.59

1.60

1.68

1.71

1.75

1.80

1.59

1.75

2.00

USD/CAD, End Period

0.77

0.75

0.77

0.78

0.79

0.80

0.77

0.79

0.82

Sources: Refinitiv, Capital Economics


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