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Canada’s Economy Softens Economic growth is not spilling-over from the U.S. as it normally does. It seems that currency effects will prevent Canada from coming close this year to matching America’s growth performance. Economic forecasts for 2004 are actually being revised downwards for 2004. The delayed effects of the unprecedented C$ appreciation are finally showing up. Exports to the U.S. are slumping badly. The weakness is particularly evident in automotive products – a key driver for the Ontario economy. Consumers are also holding back. Retail sales have been disappointing. Seasonally adjusted retail sales for the latest available month were running at their lowest level in a year. Auto sales have plummeted since last summer. This is a warning flag for the housing industry - it suggests a reluctance to make big-ticket purchases. Business and governments are also in the slow lane. Private companies are planning to increase plant and equipment spending by only 1.7% in 2004. The increases are narrowly concentrated in sectors such as refineries, primary metals, mining, non-conventional oil and telecommunications. Governments at all levels are being challenged by weaker than expected economic growth and resulting softness in their revenue base. The upcoming round of budgets is expected to be the most austere in about a decade. Private Sector Job Losses The February employment report showed surprising weakness. Total employment declined by 21,000 from the month before. There was an increase in full-time employment but it was all in the public sector. Private sector employment actually declined by 46,000 from the month before, more than offsetting the 24,000 increase in public sector jobs. It seems that private companies are now making an extra effort to increase labour productivity. Inflation is Declining The strong C$ and a large excess capacity gap are pushing inflation down sharply. Measured by the Consumer Price Index, inflation declined to only 0.7% yr/yr in February. This is down from 1.2% the month before and an average of 2.8% in 2003. This sharp decline in inflation is all the more remarkable considering that the world oil price has recently reached a 13-year high. The comparable U.S. inflation rate is a full percentage point higher at 1.7%. How Many More Rate Cuts? With inflation is running far below the official target of 2.0% and both the domestic economy and as exports showing more weakness than expected, the Bank of Canada is likely to keep cutting interest rates. Another 25 basis point cut on April 13th seems a near-certainty and the probability of a further cut on June 8th is also possible. The end result will be even more interest rate stimulus for housing markets. Variable rate 1-year mortgages are currently at 3.25% and the best rate being offered on 5-year mortgages is 4.65%. The prospect of even lower rates on shorter-term mortgages and stable 5-year rates at historic lows has the potential to push housing demand even higher than last year’s record levels.

Down Payment Requirements Eased Potential home buyers are now also finding it easier to obtain the money required for down payments. Joining GE Mortgage Insurance Canada, which introduced a similar product last year, CMHC announced in late February an expansion in eligible down payment sources. Previously, CMHC required borrowers to meet the minimum 5% down payment from their own resources. Effective March 1st, they are now able to obtain from CMHC the down payment from any source such as lender incentives or borrowed funds. Housing demand is therefore getting a double-barreled boost - carrying costs are at an extreme low and the down payment requirement is significantly eased. Strong Resale Housing Markets The resale housing market is important for new home builders as it sets the market tone and direction. The spring selling season has started out on an upbeat note. Unit sales in February were running 2.6% higher than in February of last year. This is a remarkable achievement as existing home sales set a new all-time record high in 2003. There also appears to be solid demand for higher priced homes. The average existing home price in major markets across Canada was up by 10.5% in February.

Building Permits Building permits are a leading indicator for housing starts with approximately a 2-month lead. They are currently signaling a strong start to spring construction activity. Residential building permits maintained a very elevated level in January. Permits for single-family units were up by 6.0% yr/yr in January and multi-family permits, by 17.7%. New Brunswick, Quebec and British Columbia set new records for residential building permit values in January. Housing Starts The rebound in housing starts to an annual rate of 214,100 starts in February does not appear to be a 1-month event. We expect starts to remain above the 200,000 mark through the first half of 2004. Housing start forecasts for 2004 are clustered in a relatively narrow range around 205,000 units. Last year’s official figure for starts was 218,426 units an increase of 6.5% from 205,034 units in 2002. The increase was solely attributable to multiple starts. They were up by 20.4% from the year before in urban areas. Single detached starts declined by 2.7% last year. Through the first two months of this year, single detached starts are down by 3% from the same period a year earlier, and multiple-unit starts are down by 10%. There are two provinces – Quebec and British Columbia – that are going against these national trends. In Quebec, single starts are up by 5% on a year-to-date basis and multiple starts are up by 25%. In B.C. single starts are up by 11% and multiple, by 107%. It is too early in the year for yr/yr comparisons to provide accurate assessments but they do indicate direction.

Renovation Residential renovation is showing stronger than expected gains. The yr/yr increases in major alterations and improvements have been steadily accelerating for the past year. The latest figures for the fourth quarter show a 14% yr/yr increase. This is consistent with the strength in the resale housing market over the past year. There is a direct connection between trends in existing home sales and renovation spending. There also appears to be a new contribution to the renovation market coming from rental properties. With vacancies rising as home ownership becomes increasingly attractive, landlords are making improvements to their rental properties in order to retain tenants. Supply Problems With housing starts close to peak of cycle levels and renovation spending stronger than expected, supply pressures have increased for building materials and supplies. A high level of construction activity in the United States is adding to the problem. Housing starts in the U.S. are forecast at 1.86 million units in 2004, an increase from 1.84 million in 2003. The building materials market is shaped by North American demand conditions. Canada’s new home builders are therefore facing widespread cost increases and delivery delays. Lumber and OSB prices are soaring in response to supply shortages. The copper price is at an 8-year high. Also, relentless upward pressure on energy prices is having both direct and indirect effects on builders’ costs. Reprinted and Copyright: Andersen Economic Research Ltd., Royal Bank Plaza, Box 63, Toronto, M5J 2J2, Tel: (416) 364-7772

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