Canada's Housing Bubble

Ottawa -- The Canadian economy will roar back to strength in the first half of this year only to run out of fuel later in 2010 as foreign demand dwindles and the Canadian dollar appreciates on expected interest-rate hikes from the Bank of Canada, says an updated forecast from CIBC World Markets.

The economy will enter 2010 "like a lion," said Avery Shenfeld, the firm's chief economist. "But the fading benefits of [stimulus] measures, and the lingering hangovers from the past two-years' turmoil, will see us exit like a lamb. An average-looking year for GDP growth as a whole will mask some quite varied temperature readings on a quarterly basis."

In its new outlook, CIBC World Markets envisages the Canadian economy expanding 2.3% in 2010, followed by 3% in 2011. As for the fourth quarter just passed, CIBC World Markets has pencilled growth of 3.5%.

In the first two quarters of 2010, Canadian output is expected to increase by over 3% -- 3.8% and 3.1% in the first and second quarters, respectively. Then, in the third and fourth quarters, GDP growth will be under 2%, at 1.5% and 1.9% respectively.

The previous CIBC World Markets forecast had growth of 2.1% this year and 3.8% in 2011.

The firm's economists said momentum in the Canadian economy starting to build in the third quarter, with strong domestic demand, even though the headline growth figure came in at weak 0.4% on an annualized basis.

Canadian growth will push ahead at a healthy pace until mid-year, boosted by temporary factors such as the restocking of inventories on both sides of the border and real estate activity. "But this euphoric performance will give way to a much more subdued second half," CIBC World Markets said.

The hot real estate market, which has helped lead the Canadian recovery, will cool off, the firm said, as listings climb and mortgage rates begin their ascent. As a result, hiring in the construction sector to build new real estate will level off.

Meanwhile, inventory restocking is expected to reach its peak in the second quarter before dropping off, as inventories reach more "optimal" levels relative to sales, the firm said. This slowdown in inventory restocking will also temper job growth in Canada's goods-producing sector.

But in the biggest change in its forecast, CIBC World Markets now expects the Bank of Canada to boost its benchmark interest rate beginning in the third quarter, by a total of 75 basis points to 1%. Previously, Mr. Shenfeld was among the few analysts arguing the Bank of Canada would remain on the sidelines for all of 2010.

His call that the Fed won't budge on its funds rate until 2011 remains intact.

The change in the rate forecast is due to the strong first-half growth ni Canada. These rate hikes will push the Canadian dollar above parity with its U.S. counterpart, Mr. Shenfeld said, "when resource prices won't justify that strength."

Other items of note from the CIBC World Markets forecast:

• The unemployment rate for 2010 will average 8.3%, just slightly below the 8.5% level in December. The outlook has unemployment climbing again slightly in the fourth quarter of 2010.

• Headline inflation will move beyond the 2% mark in the second quarter whereas core inflation – which removes volatile-priced items, such as energy – is expected to remain below 2% for the year. The Bank of Canada sets its benchmark rate in an effort to have 2% inflation.

• U.S. GDP growth is expected to come in at 2.8% for 2010 and 2.4% in 2011. Again, like Canada, growth will be robust in early 2010 and peter out later in the year, with fourth-quarter expansion at a meagre 0.7%.

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