The first of G7 central banks to initiate multiple cuts

Canada’s central bank sees real estate becoming an even stronger part of the economy. Bank of Canada (BoC) announced a cut to its key interest rate this morning, as widely expected by markets. The central bank justified the decision by noting the progress made on inflation, as well as excess supplies and labor market slack. They see rate cuts providing a boost to Canada’s economy, especially real estate investment—where they expect “robust growth.” 

The BoC policy rate decision is exactly what the market had almost unanimously expected. The overnight rate was cut by 0.25 points to 4.5%—returning to January 2023-levels. For those with a short memory, this was the level that the BoC previously announced would be a pause, resulting in a frenzy back into the market. Two more additional hikes were subsequently made to calm expectations.

The BoC estimates that rate decisions take between 18 and 24 months to be fully reflected in the market. The past two cuts essentially just rollback the influence of these two moves before they’ve had time to fully impact markets. As a result, the cuts will make an impact on borrowing, but it won’t be to the same extent as ones made to fully adjusted positions. 

One of the factors expected to drive Canada’s economic boom is—you guessed it, real estate. The central bank’s announcement notes, “residential investment is expected to grow robustly.”  

For those unaware, residential investment is the direct contribution that housing makes to GDP. It includes output from new home building, major renovations, and ownership transfer costs. Once again, the most direct contribution—it’s far from the only contribution. There are many industries that generate significant activity from housing that are considered indirect, such as finance and construction. 

Excessive residential investment is seen as one of the red flags for a real estate bubble. After all, residential investment can’t exist without more credit, which is future income (and consumption). More bluntly, it creates near-term economic activity at the expensive of future activity. In addition, it’s not a good sign when an economy has to dedicate resources increasingly to where people will live, instead of the jobs people in the homes will do. 

Canada’s share of GDP dedicated to residential investment is signficantly higher than US (https://www.statcan.gc.ca/en/start). Not just the US today, but also back in 2006—when they were at the peak of their bubble. The concentration was so dangerously high that experts warned it amplified vulnerability to the point a failure could be critical. That level would be an improvement for Canada. 

Overallocation into any industry is problematic, since a single shock can lead to an abrupt correction. The BoC notes residential investment will improve the economy with lower rates. It also later notes that population growth is projected to slow in 2025. However, it never seems to connect how the two issues can collide. 

If you want to discuss the details of how this change may impact you in more detail or want to review your portfolio, we are always available. Please email or call anytime. Have a wonderful day.

Tony De Thomasis, Bsc, CFPPresident[email protected]905 731 9800 ext 226

Jason De Thomasis, BMOS, CFPCertified Financial Planner[email protected]905 731 9800 ext 229

Renata De ThomasisExecutive Assistant[email protected]905 731 9800 ext 232

Chaojun (Seven) Zhu

Associate[email protected]905 731 9800 ext 237

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