Risk of a housing slump, rising loonie mar good news for Canadian economy

Bank of Canada governor Tiff Macklemhad some optimistic comments when he met with reportersWednesday following his latest Monetary Policy Report. But, as usual, the risks for the economy make far more interesting reading.

One of those risks couldbegin showing itselfin real estate data expected later today.

When the Canadian Real Estate Association releases its latest price and sales numbers for resale homes, there may be early signs that a moderate decline in demand for housing could changeinto what the bank has warned could become a "pronounced slowing."

As usual, as smart as they may be, the clever people who advise Canada's top central banker can only make educated estimates about what the future holds for the domestic and global economy, based on the data they collect now.

But overall, a newly announced cut in bond-buying stimulus by the Bank of Canadafrom $3billion to $2billiona weeksignals a growing confidence byMacklem and his advisers that the Canadian economy is on the mend.

Canadians more confident

"Canadians and Canadian businesses are more confident and that, we think, will be reflected in their spending and investment decisions," Macklem told reporters Wednesdayat the bank's virtual news conference.

Effectively Macklem foresees a strong consumer-led economic boomone that he said he had contributed to himself.

Asked whether he would suggest consumers should get out and shop, Macklemdeclined to give personal advice. Except by example. "I bought an exercise bike and I will admit it's helped me get through this crisis," he replied.

Part of Macklem's optimism is the idea that an expected surge in consumer spending will help motivate businesses to invest to expand capacity. And astrong U.S. economy, where most Canadian exports go, means businesses here will be looking to gear up for externalmarkets, too.

A sharp rise in inflation south of the border this week, hitting a new 13-year high of 5.4 per cent, is a sign the U.S. economy is struggling to fulfil demand in its own expanding economy.

Maybe Canada canhelp.

"It's clear that the U.S. economy is experiencing some capacity constraints," said Macklem. "We do expect the demand for our exports will be lifted by that strong U.S. economy."

Like his U.S. counterpart, Fed Chair Jerome Powell, Macklem insisted once again that inflation remains temporary and isexpected to snap back to two per cent by 2024 oncepandemic-related disruptions are over.

But whenreporters asked questions that implieddoubts inflation would so easily disappear, Macklemrevealedthe Bank of Canada has uncertainties of its own.

In fact, the centralbank's monetary policy release, posted before Macklem spoke, made it clear how inflation remains a moving target.

Inflation still transitory

"The factors pushing up inflation are transitory, but their persistence and magnitude are uncertain and will be monitored closely," it said.

A questionthat Macklem did not address directly was how inflationary wage pressure might be affected by the so-called transitory price increases. As previously discussed, even if they only last for a year or two, prices rising at rates of fourand five per cent create sharp cuts in the spending power of wage earners.And whether individually or as part of a union, workerswill be negotiating to get that spending power back.

Rather than addressing those future wage demands and their impact on the path of inflation, Macklem'sreply was retrospective. "To this point, wages are really quite subdued," he said.

As mentioned, some of the most interesting parts of this week's policy report were in the final section that itemized "risks to the inflation outlook."

Those risks could lead to inflation being higher than expected, including astronger-than-expected burst of consumer spending, or longer-lasting supply bottlenecks for either parts or for labourthat will add to costs.

On the gloomier side, things that could pull inflation below the bank's current expectations include a new outbreak of COVID-19 infections, especially among the unvaccinated; weaker than expected exports,potentially worsened by a rising loonie; and a slump in global growth that the bank currently has pegged at seven per cent for this year.

But for many Canadians, one of the most worrying risks could be something the central bank also addressed in a May report on the country's economic vulnerabilities: The price of houses.

While the central bank and many others would be pleased to see some of the fevercome out of Canada's notoriously red-hot real estate sector, the risk is that a decline could go too far.

Whether in today's CREA numbers or in coming months, many expect to seethat prices and sales have begun to moderate.

People don't need as much house

"The base-case projection includes a gradual moderation in housing market activity," said this week'sMPR."There is a risk that adjustment could be faster or more pronounced."

A reversal of that kind, said Macklem, could be the product of otherwise benign economic forces, as familiesare no longer driven to scale up their living space because that's where most of their lives happened, from work to school to recreation.

"Now that we can go to a restaurant, do you still want a bigger kitchen?" Macklem asked rhetorically, by way of explanation.

WATCH|The economic dangers of skyrocketing home prices:

The economic dangers of skyrocketing home prices

3 years ago

Duration 2:04

Housing sales and prices hit year-over-year record highs in the Greater Toronto Area and experts warn it is a dangerous pattern across the country, threatening the overall economy.

"A rapid adjustment in the housing market could also have adverse effects on consumption, and these could be made even worse if house prices were to decline," warned the policy report.

In an economy where housing plays such a big role, that could be a big setback, especially while total employmentand business investment are still running significantlybelow pre-pandemiccapacity.

That's one of the reasons thatwhile moving slowly to reduce stimulus in the form of bond purchases, the Bank of Canada insists it is far from ready to beginraising interest rates.

InsteadMacklem has chosen a midpoint between pumping up the economyand letting out a little air.

Follow Don Pittis on Twitter @don_pittis