Economist says repercussions of rate-hiking could be far worse than expected
While many bearish prognosticators are already seeing a rate hike-induced recession ahead for the Canadian economy, one prominent economist is predicting that it will be even worse than the consensus forecast has it.
In a report for the Financial Post, David Rosenberg, founder of Rosenberg Research & Associates, Inc., and economist, along with his colleague Julia Wendling, walked through the potential outcomes from the aggressive rate-hiking by the Bank of Canada, along with the weak residential real estate market and high levels of consumer debt.
They predicted real gross domestic product (GDP) would decline by 1.4% because of a reversion to the mean in housing-related consumption expenditures and residential investment.
“[T]his is a best-case scenario, since a pullback after years of excess typically leads to such measures going through the mean to the downside,” they said.
Should employment in the construction industry normalize, they said, the unemployment rate might also increase by up to 1.4 percentage points from its present level of 4.9% to 6.3%.
The damage may get worse than even those models forecast, they said given the state of household balance sheets and the economy's record levels of exposure to the real estate market. Real estate as a share of disposable income stands at 563%, and the share of new mortgages with variable rates is 55%.
With real estate-related consumption spending and residential investment increasing to 11.4% from a low of 7.7% in 1995, the housing market's contribution of GDP has been steadily increasing in recent decades.
“And while the housing market nationwide has undergone an extended bull run, we believe the current rate-hiking cycle by the Bank of Canada combined with weak fundamentals are likely to take their toll in the coming months,” the pair said.
After quickly scanning the historical records to determine how a reversion to the mean in these two crucial housing-sensitive components could impact real GDP, they predicted housing-related costs would need to decrease from 6.1% to 5.3% of total spending, and residential investment would need to decrease from 36% to 32% of total investment to have a significant impact. As a conservative estimate, they predicted real GDP would decrease by 1.4% as a result of the sum of these two losses.
Turning to the labour market, they said approximately 283,000 industrial workers may be laid off if the share of construction employment in the workforce revert from 7.9% now to its long-term average of 6.4%. That would cause the unemployment rate to rise from its current 50-year low of 4.9% to 6.3% –approximately in line with the unemployment rate that prevailed in mid-2008.
Consumer sensitivity to a slowdown in the housing market is likely to be increased, given that the real estate market is currently valued at 560% as a share of disposable income, reaching an all-time high in the first quarter of 2022. The impact to consumption via the negative wealth effect, they predicted, will neither be short nor shallow.
“Furthermore, unlike in the U.S. where fixed-rate mortgages prevail, the share of new homeowners opting for variable rates has climbed to a whopping 56 per cent in the first couple of months of 2022,” they added, making consumer spending even more vulnerable to BoC hawkishness.