Looking ahead at the 2011 economy

1. What is your general outlook for the Canadian economy during 2011?

I think it's going to be a relatively weak year. We'll be at roughly 2 per cent economic growth, which is relatively slow growth ... You have to remember that over the past decade the government accounted for 40 per cent of economic growth. But this won't be the case anymore. Whenever you have a surplus, the government is a positive in the economy. But in five to six years the government will be a negative as far as economics are concerned, not a positive and that's something we'll have to get used to.

So the federal government is in a mode of cutting spending and that's why it will not be able to support economic activity to the extent that it used to, so we'll have to find another engine ... The government can help this process by maintaining conditions in the country that will stimulate investment activity

2. What developments do you foresee in the residential resale housing market during 2011?

The market will be a very challenging one. Prices will continue to go down and real estate activity will flatten. Beyond that, I see the housing market stabilizing in the second half of 2011, but it will level off to a point that won't even be close to what you have seen in 2008 or 2009.

I see house prices continuing to fall by another five to seven per cent after losing close to five per cent already. So there's been a 10 per cent decline in house price from the peak. But in the west you'll see more declines than in central Canada.

I think that the west is more overvalued. If you look overall market, in my estimation it's roughly overvalued by 10 to 11 per cent. In the west in some places like Vancouver you see overvaluations of close to 17 to 18 per cent. The softness there will be more pronounced than in central Canada.

But you have to remember that just because the market is as high as 17 per cent doesn't mean it'll decline by 17 per cent. In order to see a crash in the housing market, there would need to be two preconditions: one is a subprime type situation; the other is interest rates going sky high. But those scenarios are not very realistic at this point. We know that the quality of mortgages in Canada is much better than the U.S.

I see a situation in which real estate activity will be much weaker than in 2009. So you can see there's a significant decline in every element of the housing market and those declines will continue mainly in the first half of 2011 ... and prices may only move with inflation.

3. What developments do you foresee in the home construction market during 2011?

When the housing market slowed down, you not only had the direct impact of declining housing starts, but you also have the spinoff effects in terms of construction employment and other factors that were very strong drivers of economic activity in 2010, but won't be as strong in 2011.

When you look at the HST and the fact that so much activity was borrowed from the future, I think that the next few months will be very difficult for the housing markets in terms of new home construction. Infrastructure activity will not be there as well, so that factor will be a negative for the construction industry.

We're already seeing significant signs of softness in some pockets and that will continue. So I think the start of 2011 will not be very positive for housing starts ... By the middle of the year, housing starts will only level off, not rise.

4. How much of an effect has the introduction of the HST had on the Canadian real estate market? Will the tax no longer be a factor in 2011?

The effect of the HST is very difficult to quantify, but it's definitely there. During the first half of 2010, we saw a huge increase in activity and in the second half of 2010 we saw significant slowing. So it's clear the HST factor affected the housing market in a very significant way. We don't know how much, but we know it did.

So part of the slowing we've seen in the second half of 2010 has been a bit exaggerated. It will continue ... over the next few months but won't be as rapid, and by the middle of the year it will begin to level off. So the main impact of the HST was on the market during 2010, and it will be less of a factor in 2011.

5. Do you foresee further interest rate hikes in 2011? Why or why not?

I think that interest rates won't rise for most of the year reflecting the fact that in the U.S. the Federal Reserve is not moving its rate, and the fact that the housing market in Canada is slowing. So there's no need to raise interest rates in any significant way, given the Canadian dollar is so strong.

If the Bank of Canada divorces itself too much from the Fed, we'll be risking an even stronger dollar, which will not help the manufacturing sector. So I think a reasonable assumption is that the interest rate will not move until mid to late 2011.

You don't raise interest rates just for the fact that you need to keep the option for stimulus, especially when you risk stalling the economy just to do so. We are not in the position to play with the interest rate too much and the situation is very uncertain, so we shouldn't risk it.

6. Will the government need to continue using fiscal policy to stimulate the economy?

I think it's time to stop with the fiscal stimulus because there's no need for it anymore. And if we need to stimulate the economy, we should start with monetary policy. You cannot have the government spending and the Bank of Canada raising interest rates; it just doesn't make sense. If you need to stimulate the economy go with monetary policy, then go to fiscal policy. You don't want to continue with fiscal policy primarily because of the difficulty in closing the federal budget deficit gap, which clearly has negative implications.

At this point, after we've accumulate this deficit, we've got the economy out of recession, so this is the time to stop. So I think that both monetary and fiscal policy should take a break and allow the economy to regain its footing.

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