Wednesday, December 20, 2006

Canadian Inflation Eases, Retail Sales Boom, Future looks Good for Real Estate


-Fed remains on hold as retail sales boom and inflation eases
-Canadian international trade and manufacturing
-Shipments weak while productivity puzzles

December 15, 2006
It may be that the easiest job in the world this week belonged to the statement writer for the Federal Open Market Committee (FOMC) who added just a handful of words to the previous missive (the most significant of which were the that the housing market is seen now as “substantially” cooling and that some of the recent economic indicators have been “mixed”). Despite our efforts to turn this molehill into a mountain (see our commentary), there was not a great deal to glean from the Fed other than maintaining the status-quo. By contrast, the economic data released this week offers a better, although indirect, window into the Fed’s thinking.

Arguably the single most important piece of U.S. economic data these days is the retail sales report, as it will provide the first indication that the correcting housing market has begun to restrain consumer spending. Here the news was shockingly positive, as retail sales in November trounced the market expectations by rising 1.0%. It is equally encouraging that the gains were broadly based. The ex-autos and gasoline measure rose by a strong 0.9%. Even October’s worrisome 0.4% decline was revised higher to a relatively more benign fall of 0.1%. From the perspective of the Fed, the greater momentum in consumer expenditures reinforces their case to remain on hold for the time being in hopes that the retrenchment in the housing market remains well-contained, leading the overall economy to a coveted soft-landing.

Meanwhile, this morning’s CPI report likely generated a measured sigh of relief at the Fed as core inflation surprised the market and eased by a tenth of a percentage point to 2.6% in November. Even though core inflation remains above the Fed’s comfort zone, the three-month annualized trend stands at an extremely reasonable 1.6% despite the fact that shelter costs remain elevated. As the housing market continues to cool, shelter costs will likely follow, leading to a further moderation in core prices. When combined with our view that the consumer will eventually rein in their spending, the stage will be set for the Fed to deliver a modest 75 basis points of rate cuts beginning in March of next year.

More weakness in Canadian international trade and manufacturing

In Canada, this week’s data highlighted the challenges facing the economy. First up was the international trade report for the month of October. At first glance, while a $200 million fall in the trade surplus is not an ideal outcome, it was expected given the fall in energy prices and slower growth in the U.S. economy. Upon closer examination, however, the decline in October’s trade surplus was actually closer to $700 million after factoring in the upwards revision to September’s surplus. This development has two significant implications for the overall economy. First, with a shaky start to the final quarter of the year, the growth of exports is forecast to fall by 3.6% in Q4, contributing to the lacklustre 1.8% growth rate expected for real GDP (our complete quarterly economic forecast will be released early next week). Second, in isolation the upwards revision in September has the potential to push real GDP growth in the third quarter higher. However, trade does not exist in a vacuum and odds are that some of the other components of growth (likely consumption and inventory investment) may also be revised lower to reflect lower import growth – likely offsetting part of the impact of the trade revision.

The second significant release in Canada was October’s manufacturing shipments. The details here were not pretty either. While the sector managed to avoid duplicating the dramatic 3.2% drop observed in September, shipments slipped by a further 0.1% – marking the third consecutive month of declines. Although new and unfilled orders picked up a touch, signaling a slightly less pessimistic view of the future, they too are coming off of significant declines in recent months. Suffice to say, Canadian manufacturers will continue to face a tough road ahead before feeling the boost from an expected pick-up in the U.S. economy in the second half of 2007.

Canadian productivity puzzle

We also learned this week that labour productivity in Canada fell by an annualized 0.3% in the third quarter, which was a much weaker outcome than we had expected. This marks the second consecutive quarterly decline, reinforcing the gradual deceleration in productivity observed over the last year. The surprise lay in the reported 2.4% increase in hours worked which was entirely at odds with the 0.6% quarterly decline reported in the Labour Force Survey (LFS) (Recall that labour productivity is the ratio of output to hours worked). While there are some methodological differences between the two measures (i.e. for the purposes of calculating productivity only the business sector is included while the LFS is an economy-wide measure), the sheer magnitude of the difference is suspicious and its effect is not trivial. As we noted in our recent report “A Primer on Potential Output” (available at, the growth of labour productivity not only has implications for our standard of living, but also for the conduct of monetary policy. A lower level of labour productivity implies that Canada’s potential growth rate may also be lower. If so, less economic slack will build during the near-term sub-par performance in the economy with the implication that the Bank of Canada would be less likely to lower interest rates in the face of slowing economic growth. On the other hand, given that the productivity data has been the source of major revisions in the past, it will be interesting to see if the fall in Q3 productivity is one day revised away. Thanks to this article from R. Paul Chadwick TD Canada Trust.

This will surely have a more positive impact upon our Toronto and GTA real estate marketplace and should allow for a very healthy winter and spring market to come!

For more information please contact A. Mark Argentino

A. Mark Argentino Associate Broker, P.Eng.,
Specializing in Residential & Investment Real Estate
RE/MAX Realty Specialists Inc.
2691 Credit Valley Road, Suite 101, Mississauga, Ontario L5M 7A1

BUS 905-828-3434
FAX 905-828-2829

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