Overheated housing market will hold Canada back, report says

Once a growth leader among big industrialized nations, Canada's reign at or near the top may be coming to an end, says a new forecast from Capital Economics.

The projection, issued Tuesday, calls for the economy to advance by 1.5 per cent, followed by an even softer 1.0 per cent in 2014, as the country's over-built housing market moves from soft to crash landing.

That would likely put Canada behind the U.S., Japan and possibly Germany among the G7 countries in terms of growth in at least one of the years.

Capital Economics analyst David Madani, who wrote the report says, given the under-performance, he expects the Bank of Canada will keep interest rates at current super-low levels until late 2015.

The new outlook runs directly contrary to how the Bank of Canada and many private sector bank economists view the economy and housing unfolding.

While the central bank sees growth accelerating in the July-September period this year and continuing into the next two years, Capital Economics predicts the opposite scenario, with the second half of this year squeezing out a mere one-per-cent growth rate. The slow pace extends through to 2014, then picks up to two per cent in 2015.

Madani, who is the global forecasting firm's chief economist in Canada, says the main reason is that the country's housing market is poised for a correction. Most forecasters have pencilled in a soft landing, although the Bank of Canada lists the possibility of a sharp housing fall as the No. 1 domestic risk to the economy.

"I think people are really under-estimating the risks to the housing market," said Madani. "Is no one worried about this?"

Not only would a real estate correction of up to 25 per cent in prices weigh on residential construction and jobs, but it would also sap confidence and dampen consumer spending, he said.

Global real estate concerns

Other economic engines are not faring much better, Madani adds. While Capital Economics believes a stronger U.S. will boost Canada's export sector, almost every other sector will either detract from growth or offer at best tepid support.

"We've got a housing sector that's over-extended, the government sector is cutting back, you've got businesses not feeling confident right now, so where is this growth going to come from?" he asks.

As such, Madani anticipates the unemployment rate to rise from an average 7.3 per cent this year to 8.0 per cent in 2014. The jobless rate will stabilize somewhat at 7.8 per cent in 2015.

Bank of Montreal chief economist Doug Porter, whose own forecasts are darker than the central bank's but rosier than Madani, finds nothing unreasonable about the Capital Economics analysis. He does not share in the pessimism over housing and believes the U.S. recovery will help rescue Canada's economy from sinking as low.

During a recent news conference, Bank of Canada governor Stephen Poloz also pointed to improving conditions south of the border for his relatively optimistic growth path scenario. In particular, Poloz said, private sector demand in the U.S. had turned bullish, which should boost demand for Canadian exports of lumber, and machinery and equipment.

Rate impact

The new forecast comes a day before Statistics Canada reports on the country's gross domestic product performance for May, which the consensus view predicts will show a relatively strong 0.3 per cent pick-up.

That will have little bearing on the longer-term trend, however. The Bank of Canada, for instance, has signalled a one-per-cent second quarter overall, which includes May, due to the temporary shocks of the Quebec construction strike and the Alberta floods in the last month of the period.

An expected drop in demand and prices for Canadian potash as a result of an predicted supply glut could further detract 0.1 percentage points from third quarter GDP, CIBC said Tuesday.

Hiccups aside, Madani says what is ailing Canada is more fundamental. A large reason Canada outperformed the G7 in the years following the 2008-09 recession is that its housing market expanded, while in the U.S. and many other advanced nations, real estate values slid, and in some places, collapsed. But what housing gave the economy, it is now poised to take away.

"We may disagree on how it will end up, but we can all agree the housing market is now over-extended," he said. "There's not much upside there."