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Monthly Economic Letter

May 2023
Feature article

Has the Canadian housing market hit bottom?

The Canadian housing market has been a hot topic of conversation since the beginning of the pandemic. Exceptionally strong price appreciation in 2020 and 2021 came to a screeching halt in 2022 when interest rates began to rise.

Between February 2022 and March 2023, the average price of a home in Canada fell by 17.5% according to the Canadian Real Estate Association data, but during the past three months, prices have stabilized in Canada. While they’re no longer falling in most regions, they’re not increasing significantly either. Many people are wondering if the bottom has finally been reached and what’s next for the Canadian housing market.

An unclear picture of what lies ahead

Several factors must be considered when assessing where the residential market will go in 2023 and 2024. In the short term, the market is driven by market conditions, including the economic outlook, uncertainty and, of course, the direction of interest rates. Over the longer term, fundamental factors will drive housing demand, namely population growth.

Economic turbulence will hinder a market recovery

Economic conditions have been changing rapidly since the pandemic. Uncertainty is high and continues to grow. Inflation remains elevated and central banks, outside of Canada, continue to raise interest rates.

With each new rate hike, the banks increase the risk of overdoing it and pushing the economy into recession. Other factors contributing to the high level of uncertainty include rising geopolitical tensions, financial institution failures in the U.S. and the threat of a U.S. debt ceiling crisis. When uncertainty is high, consumers tend to shy away from buying a house and making other major purchases.

Stable interest rates are helping

A pause in the Bank of Canada’s rate increases since the end of January is helping reduce uncertainty in the country and stabilize real estate prices.

This tightening cycle has been historic in its strength and speed. Financing costs are the key factor affecting housing demand. While rate increases take several months to work their way through the economy, the real estate market reacts more quickly.

According to the Bank of Canada, 75% of the total impact of a 100 basis point interest rate increase is felt in residential activity within five quarters. We are currently in the fifth quarter since the bank’s first hike, suggesting the bottom is near in those real estate markets where it has not already been reached.

In April 2023, the five-year mortgage rate stood at 6.5%—the highest level reached since December 2008. The good news is that this rate has been stable for the past six months, giving Canadian households time to adjust.

Ever growing needs

Canada's population growth accelerated to a record pace in 2022. There were more than one million new Canadians compared to 2021. This population growth is significant compared to other OECD countries. For example, France saw an increase of just 130,000 new residents and the United Kingdom 228,000 over the same period.

In fact, Canada's population growth rate of 2.7% would place it in the top 20 worldwide with immigration contributing most to the growth in 2022. This population growth will support both household consumption and residential real estate demand despite the higher interest rates.

However, an increase in the number of permanent and temporary immigrants will also pose additional challenges for the housing market in some regions of the country where supply remains under pressure. Home affordability will continue to be an important issue in Canada, especially because housing construction is facing several difficulties—including high input costs.

Market weakness expected to continue

Activity in the resale market may continue to slow. While sales volumes are already at a level only seen in recent recessions, they could continue to decline.

While rates will remain high for some time to come, Canadian households are slowly getting used to this new reality. Now that the bulk of the interest rate shock is behind us, Canadians will further adjust and budget accordingly for major purchases.

Therefore, we could see small price drops in certain markets in 2023, but at the national level, a price plateau seems to have been reached. However, it will be several more months, around the turn of 2024, before the market begins to grow again.

The impact on your business

  • Businesses in the residential, construction and furniture sectors will continue to experience weaker demand as a result of past interest rate increases. However, stable rates indicate that the bottom is near in markets where it has not already been reached.
  • Population growth is increasing the nation's housing needs. In the longer term, the supply of homes will need to increase more rapidly to ensure a more balanced market. Prices are expected to resume an upward trend by the end of the year and gain momentum in 2024.
  • With higher interest rates and depressed wealth effects from lower home prices, households will be spending less money elsewhere in the economy. Thus, demand in non-residential sectors should continue to moderate.
Canadian economy at a glance

The slowdown is setting in

Growth continued in Canada in February, but the momentum the economy has been enjoying in recent months finally seems to be fading. At least that’s what Statistics Canada's first estimates for March suggest. Signs of a slowdown are multiplying, which will probably reinforce the Bank of Canada's preference to keep its policy rate where it is when it makes its next announcement in June.

First quarter beats expectations

Monthly GDP growth continued in February with a gain (+0.1% from January), which was below preliminary expectations announced by Statistics Canada. Despite an expected contraction of GDP by 0.1% in March, economic activity was still expected to perform well in the first quarter, coming in at an annualized rate of 2.5%, compared to the last quarter of 2022.

Uneven growth in February

While below expectations, the Canadian economy still performed well in February, although growth was less widespread than in January. Almost half of the 20 or so sectors surveyed slowed during the month. Sectors closely tied to household consumption, including retail and wholesale trade, contracted during the month. This poor performance is not surprising considering that both industries recorded losses in sales volume. The manufacturing sector also lost momentum.

On the positive side, the construction sector appears to have begun to take off again in 2023. After having been a drag on Canadian GDP growth in the second half of 2022, the residential construction industry appears to have experienced positive growth in the first two months of the year. This surge is likely due to the strength of Canada's population growth and the interest rate pause announced by the Bank of Canada.

The employment boom is not totally over

Although still present in some industries, labour shortages are becoming less of a drag on the economy. Approximately 41,000 new jobs were created in April. However, this month, all of the increase was part-time. The involuntary part-time rate fell to 6.4%—the lowest level in 2023.

With an economic slowdown taking hold, job gains will be increasingly rare in the coming months and may be replaced by employment losses. The unemployment rate may rise slightly in the second half of the year as job vacancies decline rapidly and immigration intake continues at a high level.

Stubborn core inflation could force a rate increase

The economic news remained broadly supportive of the Bank of Canada's pause in its tightening cycle. However, economic activity in the first quarter was probably still above what the central bank would have liked to see and the labour market still too tight. It would appear that several members of the bank’s Board of Governors feel core inflation is too high to completely rule out a further interest rate increase.

Nevertheless, inflation as measured by the annual change in consumer prices continues to be on a downward trend and at a good pace. CPI growth fell from 5.2% in February 2023 to 4.3% in March and the three-month change remains encouraging. The trend is expected to continue this spring with favourable comparisons to last year when commodity prices exploded following Russia’s invasion of Ukraine.

However, the core consumer price index that excludes more volatile factors such as energy and food has been slower to correct.

Monetary policy continues to slow price growth, but the fight against inflation is not over. The policy rate should remain at 4.5% for the rest of the year unless there is a major turnaround in the economy.

Impact on your business

  • The Canadian economy remains strong but is finally showing signs of slowing down. Prepare your business accordingly as you may be busier this summer than last year, especially if you’re in a consumer goods industry. Make sure you manage your inventory and keep a close eye on your balance sheet.
  • The strong performance of the economy is likely causing the Bank of Canada to question the pause in its tightening cycle. While a hike remains a possibility, we expect rates to remain steady for the year as a whole. If you have investment plans, it is unlikely rates will change anytime soon.
  • Pressure on the labour market is easing across the country. As vacancies continue to decline and the labour force increases, the pool of potential candidates is growing and the competition for workers is decreasing. Now is a good time to take advantage of this easing if you’ve been putting off hiring for your long-term needs.
U.S. economy at a glance

Red flags on the economy

The U.S. economy continued to grow in the first quarter, but there were signs of trouble ahead. A preliminary estimate points to real GDP growth of 1.1% for the first quarter, a slowdown from 2.6% in the last quarter of 2022.

Real consumption—taking inflation into account—is showing signs of slowing. It was strong in January but declined in February and stagnated in March. Other signs of slowing growth in the first-quarter were falling inventories and a deceleration in non-residential fixed investment.

Federal funds rate at 16-year high

The Federal Reserve raised the federal funds rate by 25 basis points in early May, bringing the target to between 5.00 and 5.25%. This is the highest level reached in 16 years, before the financial crisis. Although the deceleration of real GDP in the first quarter suggests the Fed’s tightening campaign is having its desired effect, the fight against inflation remains challenging south of the border.

The annual change in the core personal expenditure index was still high at 4.6% and rapid wage growth continued in the first quarter—both of which likely contributed to the Fed’s decision to boost the funds rate. However, this should be the last increase for a long time.

Third time's the charm? Another U.S. bank fails

The count has risen to three U.S. bank failures in the space of six weeks. First Republic Bank was seized by American regulators before being sold to JPMorgan Chase. For now, the crisis remains well contained. While other mid-size institutions have been seen significant deposit withdrawals, these banks have been able to rely on federal programs to counter the contagion effect and strengthen their balance sheets.

The debt ceiling crisis is back in full swing

The latest source of turbulence to hit the U.S. economy and add to global worries are debt ceiling negotiations in Congress. Treasury Secretary Janet Yellen created quite a stir when she said that the U.S. government would run out of liquidity to cover its debts as early as June 1 if no agreement is reached between the parties to raise the ceiling.

A debt ceiling tug of war has become a tradition since 1960. Since then, the debt ceiling has been revised nearly 80 times and the United States has never defaulted on its debt. Obviously, if the government were to shut down, the effect would be to create even more turbulence in an economic context already marked by high inflation, interest rate hikes and problems in the American banking system.

Job gains overshadowed by layoffs

In another sign of a slowing economy, job vacancies fell to their lowest level in nearly two years in March. What’s more, job gains, while still positive, continue to weaken as the first few months of 2023 have all been revised downward. In April, 253 thousand jobs were created in the U.S., where the unemployment rate edged back down to its historic low at 3.4%. Layoffs also reached close to 1.8 million, a 2-year high.

These factors should take some pressure off wages and support the Federal Reserve in its fight against inflation in the coming months, even if the unemployment rate remains near its current level.

The impact on your business

  • Another increase in interest rates and the difficulties of the U.S. banking system will further restrict credit conditions moving into the second half of the year. U.S. consumers should continue to be cautious in how they spend. If you rely heavily on U.S. customers, expect the demand coming from the South to be more modest in the coming months.
  • Employment continues to do well and will further support consumption in the coming months even as headwinds pick up.
  • Rising U.S. interest rates will help keep the Canadian dollar low against the greenback, which should also benefit Canadian exports.
Oil market update

Global turmoil hits oil prices

A cut in oil production announced by the Organization of the Petroleum Exporting Countries and its allies (OPEC+) took effect on May 1, but signs of a global economic slowdown still sent oil prices lower.

The OPEC+ announcement in early April helped drive up crude prices in the short term. Brent reached US$88 and WTI US$83 in mid-April. However, fears of a slowdown in global demand took over and the pressure on prices eased. In early May, the spot price for Brent and WTI stood at US$84 and US$76 respectively, while one-month futures prices were down 5%. (US$76 for Brent and US$71 for WTI.)

China remains a key factor

The Chinese economy continues to disappoint. Since the end of its harsh zero-COVID policies a little more than four months ago, the recovery of Chinese economic activity has been slow. According to the manufacturing purchasing managers' index, activity in this key sector fell in April.

Global economic outlook worsens

In addition to troubles in the Chinese economy, a slowdown in the U.S. and Europe is also contributing to weaker oil prices. Central banks in both jurisdictions continued to tighten monetary policy earlier this month, further supporting fears of a global recession or at least a slowdown in oil demand.

As well, U.S. Treasury Secretary Janet Yellen upset markets when she stated the U.S. would be unable to meets its payment obligations as early as June 1 if no agreement is reached by Congress to raise the debt ceiling. Adding to the market pessimism was rising layoffs in the U.S., which are at their highest level in over two years, and the failure of a third bank.

All in all, global economic conditions, particularly in China and the U.S.—the world's largest economies— have deteriorated rapidly since the OPEC+ production cut announcement. Thus, the reduction should not create the supply deficit feared just a month ago.

Bottom line…

Developments in recent weeks suggest that OPEC and its allies may have been right. Limiting global crude production could indeed help keep the oil market balanced in the current economic environment.

The outlook for the manufacturing sector points to a slowdown in demand for crude and continued interest rate hikes elsewhere in the world will further dampen overall economic activity. The situation will certainly need to be monitored closely, but for now, the market seems fairly balanced.

Other economic indicators

Bank of Canada won't budge in June

The Bank of Canada is expected to keep the policy rate at 4.5% at the June meeting. The Canadian policy rate has been at this level since January 2023 after increasing by 425 basis points in less than 12 months. Thus far, Canadian economic activity has been very resilient despite past interest rate increases and, employment continues to perform well. However, the slowdown is starting to take hold, but more importantly for gauging the direction of interest rates: inflation is falling. It is unlikely that the Bank of Canada will resume raising interest rates, although it still says it is open to doing so, if necessary.

Loonie still flying low

The loonie lost more feathers in April as many red flags are being raised. The Canadian currency has hovered between US$0.74 and US$0.73 over the past month. Lower oil prices and recession fears will have favoured the U.S. currency despite growing uncertainty south of the border. The Canadian dollar should remain in that same range in the coming weeks.

Optimism stalls, but remains in April

In April, the CFIB's business confidence index for the coming year rose marginally from 55.3 to 55.7. Clearly, businesses are still on edge, but the index continues in the right direction. An indicator of 50 indicates that as many business managers expect the business environment to worsen as to improve over the next 12 months.

Key indicators—Canada

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