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.”
Bank of Canada Cuts Rates, Cites Weak Economy & Inflation Progress
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.
Canada’s central bank cited progress on inflation and negative economic data. Headline CPI fell to 2.7% in May, proving the previous month was a blip. Oversupply, rising unemployment, and slack in the labor market were further concerns cited. These factors all imply weaker demand, which is the primary driver of inflation, likely making the central bank more confident in their decision.
The BoC also made a brief mention of Canada lagging global economic growth. Annual global growth is now forecast at 3% through 2026. Much slower growth is expected in Canada at just 1.4% in 2024. Improvements are expected in 2025 (+2.1%), and 2026 (+2.4%).
Bank of Canada Expects Real Estate Investment To “Grow Robustly”
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. 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.
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