By Andrew Snook and Ted McIntyre

Interest rates, inflation, immigration and housing crash fears muddy the waters of our 2023 outlook

Volatility is the new normal, Tom Standage, deputy editor of The Economist, related last month in the magazine’s “The World Ahead 2023” outlook. Apart from the continuing war in Ukraine, Standage cited possible flashpoints this year being Taiwan/China, Armenia/Azerbaijan and Turkey/Greece, as well as more vitriolic politics in the United States.

“The pandemic marked the end of a period of relative stability in geopolitics and economics. Somebody has called it a 20-year-long nap, or a holiday from history. We essentially had low interest rates, no inflation to speak of and relatively few great power conflicts,” Standage says. “And now it’s all back. Today the world is much more unstable. It’s convulsed by the unpredictability of geopolitics. We’ve still got the aftershocks of the pandemic rippling through our economies. We’ve got economic upheaval, the return of inflation and extreme weather, which just seems to be getting worse. And we’ve got rapid social and technological change. So unpredictability is the new normal, and there’s no getting away from it.”

But you’ve got to try. Here at home, the Bank of Canada raised interest rates seven times in 2022—from 0.25 to 4.25%—to slow down inflation and try to stablize the economy, with expected results for the housing market.  

“We have already seen significant impact from the tightening of monetary policy,” says Robert Hogue, Assistant Chief Economist for RBC Economics at the Royal Bank of Canada. “On the whole, retail-side activity has slowed down significantly since March, and pre-construction sales have also plummeted, and that’s directly related to higher ownership costs that higher rates imply. To some extent, this is how monetary policy gets transmitted to the real economy—through interest-sensitive sectors, and housing/housing construction is a primary [example].

“Throughout the year, the Bank of Canada will obviously monitor inflation very closely, and if it behaves the way they expect, probably by the end of 2023 we’ll be talking about it beginning to roll back some of the increases that we’ve seen over the last several months,” Hogue predicts.

CMHC Deputy Chief Economist Aled ab Iorwerth forecasts a mild recession. “Obviously, this has all sorts of implications for home builders,” ab Iorwerth says. “We’ll see a lot of economic weakness and the labour market slowing down, and that will give a lot of builders pause.”

But expect recovery to commence in the second half of this year, said CMHC’s other Deputy Chief Economist, Patrick Perrier, in CMHC’s “The Road Ahead for the Economy and Housing – Fall 2022 Update.” 

In the interim, look for the national average MLS home price to have tumbled 14.3% by the end of Q2 2023 from its historic 2022 Q1 peak of $770,812. On an annual basis, Perrier sees prices to have grown 2.6% in 2022 compared with 21.3% in 2021, then declining 6.3% in 2023 before rising back 2.1% in 2024.

The CMHC report states that the Bank of Canada’s three indicators of trend inflation remained unchanged throughout 2022 and that the policy rate is not expected to decline until mid-2024. “As inflation converges back to its target range by mid-2024, the Bank of Canada policy rate will also decline and stabilize at 2.5%, the midpoint of its estimate for the neutral policy rate,” the report indicates. “Other interest rates will broadly mimic the policy rate over our forecast horizon to 2024.”

CMHC believes the home building sector will experience several delays in the coming year and expects national housing starts to decline throughout 2023 to 244,000 units, but to recover in 2024 to a total of 270,000 units. 

 “Long-term, we don’t think there’s enough supply out there,” ab Iorwerth says, “so pressure on affordability will persist over time.”

Downgrading Ontario’s Outlook

The difficulty of predicting the future—even in the short term—was evidenced by Ontario Finance Minister Peter Bethlenfalvy’s fall economic statement in November, which revised its projections downward from those made in the spring 2022 budget. While last year’s Ontario housing starts fell only marginally—from 86,900 to 86,600—the 84,000 starts initially forecasted for 2023 were downgraded to 76,900. And despite the looming need for 1.5 million new homes by 2031, the Ontario government dropped its 2024 forecast from 87,300 housing starts to just 77,800.

Home resales, meanwhile, went from the -11.3% predicted in the spring to a 31.7% drop. And just as disturbing, the 1.5% increase for this coming year was revised to a 14% decrease. And as far as Ontario housing prices for 2023 go, the province went from a 2.6% growth expectation to an 8.1% drop.

There was some positive news for the construction industry, however, with the promise of an additional $40 million investment into the Skills Development Fund—a welcome injection, given reports suggesting that 100,000 additional skilled workers are needed to meet the provincial government’s objectives.

The Ontario government report also recommended caution for the economic road ahead. “Recent elevated levels of consumer price inflation in many jurisdictions around the world have prompted key central banks, including the Bank of Canada, to aggressively tighten monetary policy. If central banks determine that there is a significant risk that consumer and business expectations for elevated inflation are becoming entrenched, they may move even more aggressively and for longer,” the report reads. “This represents a significant downside risk for global economies, including for the U.S. economy. Rising interest rates also pose a risk to asset markets, including housing, as prices adjust to reflect changing monetary policy conditions.”

Further, “although supply disruptions are expected to ease, they continue to pose a heightened risk to the global economy, which is compounded by recent disruptions to major commodity markets.”

Predictable Impact

To paint the picture of the financial impact of the changing interest rates over the past year, consider a $1 million home with a 20% down payment and $800,000 mortgage. On January 1, 2022, RBC’s five-year fixed mortgage rate was 3.07%. Heading into the end of December it was 5.72%. That means today’s homebuyer will need to shell out $1,171 extra per month and approximately $101,000 extra on interest payments over the five-year term. 

So the increased rates have had the expected chill on major real estate markets across Ontario. From Jan. 1, 2022 to Aug. 31, 2022, year-over-year sales price increases were experienced in 13 of 15 cities across the province, with the exceptions of Windsor (-15.7%) and Ottawa (-1.1%). However, Fall 2022 sale price estimates showed decreases in 11 of those 15 cities.

“However, the current lull in the market is only temporary,” says RE/MAX Canada President Christopher Alexander. “Until housing supply increases, these boom and bust cycles will likely be a recurring event.”

When a Tree Falls

The lumber market has also been tough to pin down. A year ago, more than one industry expert believed that lumber would never return to $400 US (MBF/1,000 board feet), and that prices were, in fact, likely to rise. Those numbers have since tumbled from a January 2022 high of $1,329 to below the $400 mark.

According to international online data source Trading Economics, lumber is expected to decline to $356.08 US /1,000 board feet by late 2023, due to a slowing U.S. home building market. “The Federal Reserve’s aggressive tightening cycle has pushed 30-year mortgage rates to levels not seen since 2001, leading to slower home construction and souring sentiment among home builders,” the site indicates. 

But don’t expect it to slip too low, given demand issues in other areas, Trading Economics cautions. “Record-low inventories and diminished production have affected lumber prices. The war in Ukraine and the tightening sanctions against Russia and its ally Belarus, which account for more than 10% of the global export of lumber, have squeezed global supplies. At the same time, a string of sawmill curtailments, with Interfor, Canfor and West Fraser Timber announcing cutbacks, added to concerns about tight supplies.”

Keta Kosman, publisher of Madison’s Lumber Reporter, also believes supply shortages will prevent steep price drops. “The cash price of benchmark Western SPF (spruce/pine/fir) 2x4s has dropped to US$390 (per thousand board feet) on the usual seasonal slowdown for construction and for lumber sales,” Kosman said last month. “I do not see it going much below that, which is already lower than cost-of-production here in B.C. The sawmills would be losing money. There have been curtailments and downtime in the past several months. The drop in production volumes will keep the balance of supply and demand, so prices will not fall much further.”

Immigration Impact

If current national and provincial immigration plans remain intact, there will certainly be incentive to facilitate residential construction. In November, the department of Immigration, Refugees and Citizenship Canada released its immigration levels plan for 2023-25. The plan noted that Canada will target 465,000 new permanent residents this year, 485,000 new residents in 2024 and 500,000 more in 2025 for a total of 1.45 million new residents over the next three years.

“We’ve already experienced some significant challenges in recent years with skilled trades, but it’s now spread to many other sectors outside construction,” RBC’s Hogue says. “We have close to one million job vacancies across Canada. We’re seeing some movement from policymakers to focus on training new folks in construction especially.”

“On the flipside, I think increasing immigration levels will certainly lead to more demand for homeownership and rentals,” notes CMHC’s ab Iorwerth. “So, it reinforces the picture that there’s a lot of demand for housing in the long term and not enough supply.”

Much of that supply needs to be allocated to the rental side, suggests John Lusink, president of Right at Home Realty. “While I think it’s great for the country that they will be bringing in people who will, hopefully, be gainfully employed, and increase the tax base, the bulk of new immigrants will come to the GTA, where the jobs are,” Lusink notes. “This is what has been very frustrating for us in the industry. There’s been no real valid supply-side fixes. This will make the rental market incredibly difficult for those who can only rent.” 

But don’t assume that demand will overwhelmingly be for rental units, says ab Iowerth. “When people come into Canada, there has been an impression that they will be going into the rental sector, but immigrants are increasingly bringing in wealth, so they may go into the homeownership market. So, it probably represents an across-the-board increase in housing demand.”

Uncertainty Abounds

For ab Iorwerth, though, even if inflation gets under control and the Bank of Canada is able to begin reducing interest rates, there are other areas of concern. 

“Canadian households have very high levels of debt, which makes me a little bit cautious about the forecast, because it’s possible that things can go wrong with such a high level of debt,” he says.

One positive ab Iorwerth notes is that the supply chain issues plaguing the sector (and countless other industries) are starting to dissipate, which should help alleviate some of the inflated costs.

But give those changes, as well as the Bank of Canada’s, some time to work their way through the system, says Canadian Imperial Bank of Commerce chief economist Avery Shenfeld.

In a December memo to clients, Shenfeld noted that “the tightening cycle likely has reached its zenith, but we’ll need the pain of these higher rates to persist for a while to stall economic growth and thereby cool inflation.”

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