What does the economy of 2011 have in store?

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

It was clear from the start it would be a fairly slow recovery. During the end of 2009 and the beginning of 2010, growth really picked up enough for most economists to revise up their forecasts.

But the second quarter came in much slower and third quarter will be a slow grind as well. So I think we're back to what we initially thought: that the recovery will be sustainable, but will be fairly modest by historical standards.

The interest rates are still extremely low by historical standards even though they've gone up since the middle of 2010. And at the same time there will still be very strong fiscal policy until the end of the first quarter in 2011, which will continue to create of activity in the economy. We expect that the private sector is going to start to takeover more visibly in 2011 ... So overall we expect private sector spending to pick up, while consumer spending will only have modest gains.  We've already seen housing slowing and it won't be contributing to growth in the near term.

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

We've already seen the cooling of activity since the start of 2010, particularly through the spring and the summer, when resales moderated considerably ... That activity that was brought forward is not taking place right now ... Our opinion, for resales at least, there might be some downward pressure at this point but they should stabilize in 2011. We'll start seeing some steady gains during 2011 but, again, they'll be very moderate gains

You have to keep in mind that valuation to a large extent is subjective ... I pay less attention to valuation models and pay more attention to affordability measures, which do indicate there is a bit of stress on the demand side, but nothing flags a major risk. Now, there might be some exception, and Vancouver does come to mind, but generally speaking it's a slightly stressed market overall, but not to the point of screaming that there's an imminent meltdown.

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

New home construction has surprised us in recent months. We thought it would weaken more. Typically it lags the resale market by half a year. Our quarterly forecast lowered starts for Q3 relative to Q2 in 2010 but we should see a gradual improvement during 2011. But that being said I think we're looking at levels during 2011 that would be overall slightly lower than last year because we had a very strong start to 2010. So we'll see moderation in 2011, but it will be stabilizing and upward sloping.

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

There appears to be a lot of consensus on the ground level that there is a lot of confusion with the HST with respect to the resale market. Even for homeowners who knew that the actual price of an existing home was not being taxed and that the transaction costs are. The HST is essentially adding the provincial tax on those transactions.

So I think a lot of buyers tried to act before the HST was implemented, which probably contributed to bring some of that activity forward in the first part of 2010, and at the same time it probably brought forward some supply because those individuals who were putting their homes up for sale were the ones who were paying the commissions.

And now that the commissions are being taxed at the provincial level it represents quite a bit of money ... Supply has weakened considerably since the spring of 2010, which may be a result of an HST effect in Ontario and B.C.

Now we're at the stage where I think the HST effect is still causing a bit of turbulence in the market, but moving into 2011, I think it will be behind us. If B.C. goes through a referendum and repeals the HST law that's going to be another round of turbulence ... So it could turn out to be a more prolonged issue.

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

In our view, the Bank of Canada has time to pause and re-evaluate the situation. Inflation is not a threat at this point, so it has the freedom to take its time. But by the end of the first quarter of next year, we think the economic data is going to confirm that recovery is indeed being sustained and that the Canadian economy will no longer need emergency-type interest rates.

So we're expecting the Bank of Canada to raise the interest rate another 125 basis points. So by the end of the year we're looking at 2.25 per cent in the overnight rate, similarly for five-year bond rates, we're expecting some moderate increases as well. Nothing sharp, nothing that would threaten the housing market, but certainly in our view it will be trending up.

There were problems that were created in the past by having too much liquidity out there. And you don't want to run the risk of fostering asset bubbles because credit is too easy to get. So generally speaking when you don't need such low interest rates, you take them away. Right now the domestic economy doesn't look like it needs that much monetary stimulus anymore, but the

Bank of Canada is taking a very cautious approach because of the uncertainty caused by the global economy.

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

At that stage in Canada, we don't think the economy needs anymore fiscal stimulus ... The large federal infrastructure program is going to expire at the first part of the first quarter and there still is some concern that the country may need a follow-up act to sustain that activity. So I think a cautious approach is warranted. But the base-case scenario in our view does not require further fiscal stimulus.

For a more in depth analysis of the 2011 market, pick up a copy of our January issue, on newsstands now.

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