On August 31, Statistics Canada reported Canadian GDP growth at 4.5% in the second quarter. This was the fastest rate seen in six years. The Canadian economy has been on a tear in 2017, establishing itself as one of the strongest in the G7. The Bank of Canada is set to make an interest rate decision on Wednesday, September 6. Analysts expected an interest rate hike in October if the economy continued to grow at its expected pace, but this latest news has some traders betting on a rate hike this week. Odds of a rate hike are now over 50%.
The Canadian dollar reached as high as $0.81 on September 1 in response to the growth numbers and to disappointing jobs numbers in the United States.
James McPhedran, executive vice president at Bank of Nova Scotia (TSX:BNS)(NYSE:BNS), said that perceptions in Canada have improved dramatically since January and February. He also noted the concern over Canada’s near-record high debt levels. In spite of continued economic strength shown in Canada this year, the S&P/TSX Index has fallen 0.63%.
Real estate in the Greater Toronto Area has decreased over 20% since new housing regulations were introduced in Ontario. The Office of the Superintendent of Financial Institutions is proposing stringent stress testing for the uninsured mortgage market. The new rules could slice a prospective home buyer’s purchasing power by more than 15%. A report from Toronto-Dominion Bank speculated that the new rules could sink housing demand by 10% or more.
Real estate continues to be a substantial contributor to GDP growth. Though the housing market has been long overdue for a correction, a prolonged slump could have dramatic consequences. According to some real estate industry experts, new mortgage rules could potentially drive larger portions of new buyers to the shadow banking industry.
Alternative lender Home Capital Group Inc. (TSX:HCG) rose 3.1% on Friday, September 1, and 7.2% over the course of that same week. The stock dropped slightly in the immediate aftermath of the July 11 rate hike, but it has since been largely flat. There were initial concerns that a rate hike could see customers face a major squeeze because alternative lender mortgages are more sensitive to variable rates.
If the Bank of Canada opts for an increase, likely in the range of 25-50 basis points, the Canadian benchmark interest rate would be at 1% — still near a historical low. The Federal Reserve has also committed to a gradual interest rate rise in the United States, but after several incremental increases brought it to 1.25%, the Fed has struck a more dovish tone.
A rate hike will almost certainly allow the Canadian dollar to challenge the $0.85 mark and beyond. Ongoing NAFTA negotiations already have Canadian manufacturers nervous, and a continuing strengthening dollar would do little to temper that anxiety. If the Bank of Canada goes ahead with a September rate hike, I would bet on a very cautious path forward.
