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The Bank of Canada appears to be trying calm concerns about the timing of coming interest rate increases and the state of inflation. Last week, BoC Deputy Governor Lawrence Schembri said there is no firm timeline for raising rates. He said the Bank continues to wait for the excess slack to come out of the economy so that the central bank’s 2% inflation target is sustainably achieved. It expects that will happen sometime in the middle quarters of next year. There’s a lot ...of uncertainty about the timing of the closing of the output gap, so one should be careful not assuming it’s necessarily going to be the second quarter. It’s a range of six months -- that’s our best estimate, he said. The output gap or slack refers to the difference between the economy's productive capacity that is, the amount of goods and services that could be produced if all labour and capital were fully and efficiently employed and the actual level of economic output. Schembri says that it is becoming more difficult to predict when the gap is closing because the traditional relationship between labour market conditions and inflation has become harder to measure. Inflation would usually come back to target when economic slack is absorbed and the economy returns to maximum employment. But the labour market has been changed by the pandemic, making traditional measures of slack less useful, according to Schembri. Inflation continues to run hot and the BoC continues to point to temporary factors, like energy costs and supply chain bottlenecks. The Bank expects inflation to cool as employment and productivity improve.

Housing affordability has deteriorated for the third straight quarter despite stable interest rates and decent income growth. The latest Housing Affordability Monitor indicates it now takes 46.5% of income to service a mortgage in this country. By the measures used in the report affordability declined by nearly 2 points in the third quarter, following a 3.2 point deterioration in Q2. Almost all of that is the result of higher home prices. Numbers from the Canadian Real Est...ate Association show a 4.6% jump in the third quarter, with a 19% increase year-over-year. Looking forward, the report does not see any improvement for the foreseeable future. It points to fixed mortgage rates that have increased by nearly 25 basis points this month and it speculates about on-going rate increases in the coming quarters. The Bank of Canada has been clear that it is prepared to start increasing rates in the middle quarters of 2022. The report hypothesizes that a 100 basis-point increase in interest rates would result in a 12% decrease in buying power. Looming interest rate increases appear to have triggered a surge in the fear-of-missing-out among house hunters. As a result, there has been a spike in the number of buyers who are looking for pre-approvals and rate-holds. Given the increase in the 5-year fixed rate between October and November, the average homebuyer is looking at about $112 added to their monthly payment. Over five years, that adds up to more than $10,500.

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Anyone trying to forecast the course of interest rates in Canada is advised to keep one eye on what is happening in the United States. On Friday August 27th 2021 the Chair of the U.S. Federal Reserve, Jerome Powell, sent a noteworthy signal. During his address to the Jackson Hole Economic Symposium Powell announced that key aspects of the U.S. economy are showing good improvement, and the central bank could start reducing economic stimulus later this year. Since the start of... the pandemic, the U.S. Fed has been working to keep money flowing through the economy by purchasing US$ 120-billion in government bonds every month. The, so-called, quantitative easing is an effort to hold interest rates down and encourage borrowing and spending. Economists have pointed to a rollback in Q-E as a precursor to possible interest rate increases. The Bank of Canada has trimmed its quantitative easing twice since April, and has projected interest rates could start to rise in the second half of next year. The U.S. Fed had been saying it did not see interest rate increases coming until later in 2023. But the Friday’s comments from Powell did not include a timeline for Q-E cuts or rate hikes. Inflation one of the key factors in setting interest rates has been spiking in both Canada and the U.S. as the economies recover. But the central banks in both counties say it is just temporary as production and supply chains get back to normal. As always, the course of the pandemic remains the wildcard in any economic planning and forecasting.

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Much of the economic talk so far this year has centered on interest rates. The main questions have been when will they start to rise and by how much. In an attempt to provide answers economists and analysts monitor a key factor that guides interest rate policy: inflation. Inflation has been a non-issue in North America for the better part of 40 years. That’s largely because after the last significant bout of inflation, in the late ‘70s through the mid ‘80s, central banks i...n Canada and the U.S. were given the job of keeping it under control. At that time the Bank of Canada rate topped 21%, and mortgage rates looked more like credit card interest. Interest rates are the traditional tool used to control inflation. When it is deemed to be too low, and the economy stops growing, rates get trimmed to stimulate demand and spending. When inflation is too high, rates are raised in an effort to cool off the economy. Over the past month or so inflation has jumped up in both Canada and the U.S. In March, Canada’s Consumer Price Index hit 2.2% on an annualized basis. Up from 1.1% in February. In the U.S., April’s CPI came in at 4.2%. It was enough to rattle American stock markets, which experienced significant drops, at least for a day or two. But one month does not make a trend and there are mitigating factors. The increases in both countries are compared to the pandemic slump of a year ago. The corresponding employment reports on both sides of the border were weak. (Strong employment tends to drive inflation because more people have more money to spend.) And, both the Bank of Canada and the U.S. Federal Reserve have been expecting inflation spikes as COVID restrictions are loosened. Both have said they will not be responding to these temporary increases. The central banks are watching for sustained, core inflation in the 2.0% range. The Consumer Price Index covers a broader range of products, including volatile items like food and fuel, that are factored out of central bank calculations. Home prices are not part of the calculation either. Houses are considered assets, not consumer goods.

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The Bank of Canada has sent two clear signals that things are getting better, faster, than it had expected. In its latest Monetary Policy Report the Bank announced it expects to hit its inflation target sometime in the second half of 2022, rather than sometime in 2023. It has also rolled back it’s bond buying program from $4-billion a week to $3-billion a week. Anyone who is involved with a variable rate mortgage or a line of credit will take note of the first signal. The s...econd signal pulling back on quantitative easing means more over time. The Bank has been buying those bonds in an effort to keep longer-term rates lower. Many market watchers see the cutback as a strong sign that an interest rate hike is coming. BoC Governor Tiff Macklem would not be specific when asked about when an increase would come. He explained that uncertainty remains and the Bank will be guided by economic conditions as they develop. Housing remains a key driver at this point in the pandemic economic recovery. New home construction set a record in March. Starts increased nearly 22% over February, for an annualized pace of more than 335,000 units. While the Bank believes home price increases are rooted in [economic] fundamentals, it says there are signs of extrapolative expectations and speculative behaviour. Given elevated levels of household debt and the risks that households may overstretch in the face of rising housing prices, we welcome the recent proposal to introduce a fixed floor to the minimum qualifying rate for uninsured mortgages. New measures just announced in the federal budget will also be helpful. We are watching developments in the housing market very closely, Macklem said.

Yesterday morning, the Bank of Canada made its third interest rate decision of 2021 and presented projections for inflation and growth in the economy. The announcement came just as Statistics Canada reported that the consumer price index was higher by 2.2% year over year in March and as speculation ramped up that the Bank would reduce its pandemic-driven bond buying program in response to improving economic conditions. In the end, the Bank held is its overnight rate steady which is great news for homebuyers but also suggested that its policy interest rates could be affected (i.e. rise) as early as the second half of 2022 if its inflation projections are accurate.

The March report from the Canadian Real Estate Association contains some pretty astounding numbers. It is a trend we are likely to see through most of the rest of the year. Sales volumes, prices and the rates of acceleration shot up in March. Sales climbed 76% year-over-year and 5% compared to February. More than 76,000 properties changed hands in March; the highest level of activity for any month, ever. The National Average Price bounded up by nearly 32% from a year ago an...d now sits just below $717,000. As usual the country’s busiest and most expensive markets skewed the average price upwards. When Toronto and Vancouver are taken out of the calculation, the price drops to about $557,000. While the raw numbers are remarkable, it has to be remembered that the astounding rates of change as shown by percentages are coming off of the incredible slump that hit the industry when the first of the anti-COVID-19 health restrictions were put in place at this time last year. Given the nature of the market over the past 12 months we can look forward to more stunning, but somewhat misleading, y-o-y changes. Market watchers continue to pay particular attention to the sales-to-new-listings ratio. The number of newly listed homes was up 7.5% in March. Combined with the rebound in February new listings rose 25% over the two months. That added inventory is seen as the catalyst for the record breaking sales activity in March. Despite the increase, the sales-to-new-listings ratio remains extraordinarily high at 80.5%. The long-term average is about 54%.

The B word has started floating back into discussions about Canada’s housing market. The latest numbers from the Canadian Real Estate Association help to explain why worries about a bubble are on the rise. Sales activity in February jumped nearly 40% compared to a year earlier, setting a new record. Sales rose nearly 7% compared to January. The national average price surged by 25% year-over-year. New listings rebounded month-over-month in February but inventories remain... at record lows. Nationally there is just 1.8 months of supply. The Bank of Canada has expressed concerns about overheating. Governor Tiff Macklem has noted that there are signs that real estate speculation is on the rise. "What we get worried about is when we start to see extrapolative expectations, when we start to see people expecting the kind of unsustainable price rises we've seen recently go on indefinitely, and they're basing their decision on those kinds of assumptions," Macklem warned earlier this month. Other market watchers point to less bubbly factors. I think part of it is demand that built up as a result of regulatory changes in the years leading up to COVID that is playing out now. Part of it is demand that is being pulled forward from the future either in search of a home base to ride out the pandemic, or to lock down a purchase amid rapidly rising prices while securing a record low mortgage rate, said Shaun Cathcart, CREA’s Senior Economist. Tsuriel Somerville, a professor of urban economics at the University of British Columbia, believes demographic factors could be pushing the market. He also believes COVID-19 may have accelerated some transactions that would have happened anyway, but over a more extended period. Somerville says millennials who are said to be happy with renting and living in a sharing economy will eventually get into the ownership market when their demographics dictate.

A few weeks ago, in the run-up to the Bank of Canada’s last interest rate setting, market watchers were abuzz with the prospect of another drop even if it was just a, so-called, micro-cut of 0.1% to 0.15%. That didn’t happen. The Bank held steady at 0.25%. Now, the chatter has turned to the possibility of an impending rate hike. Part of the logic for this centers on the savings Canadians have accumulated during all the pandemic lock downs. By some accounts $90-billion is... bottled up in bank accounts across the country. The theory is, when the lockdowns and restrictions end Canadians will go on a spending spree, pouring that banked money into the economy. Demand for goods and services will outpace the ability to provide them, causing price increases that will push inflation above the BoC’s 2.0% target rate. The Bank will then step in with rate increases to temper spending and calm inflation. However, a number of economic observers make the point that a flash flood of spending is unlikely. They say the persistence of the coronavirus and the cumbersome rollout of the vaccines will slow the lifting of current lockdown regimes, and that alone will be a moderating influence on spending. January job numbers, showing 213,000 losses, also indicate there is still underlying slack in the economy. Further, the central bank has said inflation will have to be sustained at more than 2% before it steps in. A sudden rise in post-pandemic spending will, most likely, be a pop not a plateau.

As COVID-19 vaccines began rolling out, Canadians racked up another record-setting month for home sales. Canadian Real Estate Association numbers for December show a year-over-year increase in sales activity of 47.2%. That is a new record for the month and the biggest y-o-y increase in 11 years, by a margin of 12,000 units. Month-over-month sales jumped 7.2% from November to December, another all-time record.... A related but more esoteric statistic shows seasonally adjusted activity was running at an annualized pace of 714,516 units in December 2020 the first time on record that monthly sales at seasonally adjusted annual rates have ever topped the 700,000 mark. CREA’s preferred method of tracking home prices, the Aggregate Composite MLS Home Price Index, rose by 1.5% m-o-m in December and was up 13% y-o-y the biggest gain since June 2017. The national average price for a home hit a record of $607,280 in December, up 17.1% from a year ago. With the heavy weight markets of Toronto and Vancouver factored out, the national average price drops by about $130,000 to $477,000 For all of 2020 more than 551,000 homes changed hands a new record. It is a 12.6% increase over 2019 and a 2.6% increase over the previous record, set in 2016. The thing to watch in 2021 is the sales-to-new-listings ratio. New listings rose just 3.4% in December. The ratio now stands at 77.4%, one of the highest readings ever. The long term average is 54%.

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A recent survey by the brokerage Properly seems to reinforce current notions that people particularly millennials are looking for more space both inside and outside their homes, as a result of being cooped-up by the COVID-19 pandemic and the desire to maintain the option to work from home. According to the Properly survey more than half of millennials are unhappy with their current homes. Their preferences have shifted towards: - detached housing, 45% - ample... square footage, 44% - better home offices, 28% - backyard space, 57% - proximity to green space, 34% Of the millennials who expressed a desire for a new residence, about 8% said that they have firm plans to buy next year. That is double the 4% indicated by the rest of the population in the survey. This report dovetails with a recent survey of real estate brokers by Re/Max. It suggests move-up and move-over buyers are seen as the big sales drivers over the next year. Forty-five percent of brokers expect buyers moving up to bigger homes and properties will be a key market force. Thirty-five believe buyers moving over from other cities will drive the market. Both reports suggest that price pressure, resulting from low inventories, will continue to be the biggest consideration in buying or moving (over or up). But ongoing low-interest rates will continue to be a mitigating factor