The Bank of Canada still says it plans on hiking interest rates “over time.” When do you think that will happen, and how quickly will they increase?
CW: The Bank of Canada’s ‘low for now, but not low forever’ policy stance is likely to remain in place over the early part of next year. As downside risks continue to fade through the year, growth will move slightly above its speed limit, driving the economy toward capacity. We expect the overnight rate will hit 1.5 per cent by the fourth quarter of 2013.
JD: Our base case assumes one 25-basis-point hike in the Bank’s overnight interest rate in the fourth quarter, but in our view, risks to this forecast skew toward an even longer on-hold period, or even a rate cut. Our forecast is highly dependent on global developments such as the resolution of the U.S. fiscal cliff. A bad outcome could push Canada back into recession, requiring additional easing. A better-than-expected outcome would result in stronger Canadian growth and an earlier rate hike.
Who do you think will replace Mark Carney?
CW: I am certain the Bank of Canada’s Board of Directors will find a very suitable candidate to replace Governor Carney. I am not a betting person but if I was, I would put my money on Senior Deputy Governor Tiff Macklem. … He is ideal for the job given his education, skills, deep understanding of the Canadian economy and monetary policy, and exceptional ability to communicate.
JD: We do not have any particular insight on who will replace Carney, but we expect his departure is unlikely to materially impact the course of monetary policy in Canada. First, the Bank of Canada is mandated to target inflation of 2 per cent, so the BoC’s credibility is unlikely to change with his departure. Second, monetary policy decisions at the BoC are made through consensus by the governing council, so a new governor has limited power to dramatically change course.
Record household debt is still seen as the biggest domestic threat to the Canadian economy. How do you think household finances will fare next year?
CW: The oft-mentioned debt-to-income ratio continues to set record highs, though the cost of servicing debt is near record lows. The level of the ratio itself doesn’t cause a crisis, but it does leave the economy vulnerable to a shock. The shocks one has to be particularly worried about include: a deterioration in the labour market, a marked decline in housing, or a spike in interest rates. Barring any of these shocks, we expect continued slowing in the pace of debt accumulation.
JD: We expect the household debt-to-income ratio will continue to rise in 2013. With mortgage interest rates at all-time lows, more households are choosing to become homeowners. As interest rates normalize and tighter mortgage rules kick in, marginal home buyers will be priced out and there will be downward pressure on the household leverage ratio. In our opinion, the rise in household leverage is largely sustainable because households have not had to strain their budgets to support the rise in debt. We expect household finances will weather the weakness in the first half of the year, but the risk remains of a bad U.S. fiscal cliff outcome dragging Canada back into recession.
Canada’s housing market is already cooling after a boom in recent years. What’s in store for activity and prices next year?
CW: Our view of the housing market is one of a cooling, rather than any sort of U.S.-style crash. Our housing affordability measures are pointing to some signs of strain which, alongside the numerous rounds of regulatory tightening, suggests a softer trend in housing as we move through 2013. We expect home resales to decline by 2.5 per cent in 2013 following a flat trend in 2012. Prices are also expected to decline, dropping 1.5 per cent following a gain of nearly 5 per cent in 2012.
JD: The odds are pretty high that the Canadian housing market slows further. We expect home prices to be down 5 per cent nationally and housing starts to slow to their long run trend of 180,000 over the next 12 months. In our opinion, the slowdown in housing starts will be focused in the multi-family segment, where the majority of recent construction activity has been.
Comments have been condensed and edited.