The road ahead for the economy and housing — fall 2022 update

The world and Canada’s economic and interest rate landscape has changed significantly since the publication of our latest Housing Market Outlook (April 2022) and subsequently, The road ahead for the economy and housing (July 2022).

Patrick Perrier
Deputy Chief Economist

As Deputy Chief Economist, Patrick Perrier is part of a team of housing economists and researchers striving to improve Canada’s understanding of drivers and barriers in housing markets and how they impact affordability. Patrick is also part of a diverse national team of researchers and analysts investigating barriers to housing supply and potential solutions. 

Highlights¹

• Inflationary pressures have been stronger and more persistent than expected since we published our Housing Market Outlook in April 2022.
• This has led to significantly sharper than predicted interest rate hikes in Canada and other economies. Interest rates are expected to rise further given the need to reduce inflation.
• The Canadian economy will enter a modest recession by the end of 2022 and start recovering in the second half of 2023.
• The national house price is expected to decline by close to 15% by Q2 2023 from its historical peak in Q1 2022 as housing demand slows with rising interest rates and deteriorating economic and income conditions.
• Despite this house price decline, ownership affordability will not improve as the benefit from lower prices will be offset by rising interest rates. Rental affordability pressures will increase with rental demand as fewer renter households can access ownership.

Economic and interest rate landscape and outlook

Forecasters — including CMHC — were expecting an orderly elimination of excess economic capacities² from the sharp economic downturn in the early months of the pandemic and a gradual rise in interest rates as central banks aimed to keep inflation under control.

Since then, inflation has risen more than expected and far exceeded targeted rates in several inflation-targeting economies, including Canada. The war in Ukraine and the resurgence of COVID-19 infections in China contributed to increasing energy and food prices. These factors have also prolonged the global supply-chain disruptions that were initially caused by the pandemic.

As demand continued to grow with the pandemic-related recovery, the global and Canadian economies have witnessed more demand and inflation pressures so far in 2022 than expected last spring.

In Canada, the annual inflation rate — or rate of increase — in the all-items Consumer Price Index (CPI) was 8.1% in June. This increase is a near 4-decade high and declined to 7% in August, mostly due to decreasing energy prices over this period.

Despite this decline, our view is that inflationary pressures have not eased as the average of the Bank of Canada’s 3 indicators of trend inflation — which better reflect economic imbalances — have remained unchanged since June.³

This strong and persistent inflation landscape led to a sharper-than-predicted rise in monetary policy and other interest rates so far in 2022. From March 2 to June 2022, the Bank of Canada raised its policy rate from 0.25 to 1.5% and applied 2 additional hikes thereafter to bring this rate to 3.25% on September 7. We predict this policy rate will continue rising and peak at 4% by the end of this year.

This policy rate rise is also increasing households’ and businesses’ borrowing rates. As inflation converges back to its target range by mid-2024, the Bank of Canada policy rate will also decline and stabilize at 2.5%, the mid-point of its estimate for the neutral policy rate.⁴ Other interest rates will broadly mimic the policy rate over our forecast horizon to 2024 (see chart 1).

In the first half of 2022, Canada’s economic activity grew 3.2% (annualized rate), a slowdown from the near 6% rate of the second half of 2021. Monthly economic indicators suggest the economy slowed further in the third quarter. The negative impact on economic activity from past increases in the monetary policy rate will continue to strengthen and expected additional rises by year-end will gradually add to this negative impact.

As other economies are also taking actions to reduce inflation with higher interest rates, external demand for Canadian goods and services will weaken. This will add downward pressure on the economy.

We expect the Canadian economy to enter a recession — although shallower (or not as severe) than previous ones — in the last quarter of this year and start recovering in Q3 2023. Canada’s real Gross Domestic Product (GDP) should decline by 2.1% from its Q2 2022 peak to Q2 2023. On an average annual basis, GDP growth should soften from 4.5% in 2021 to 2.8% in 2022. GDP should decline by 1.25% in 2023 and grow by 2.9% in 2024 (see chart 2).

The labour market performed well in 2021 and the first half of 2022. Employment growth was still robust in the first half of 2022 at 3.6% (annualized) despite declining from 6.5% in the second half of 2021. Tight labour market conditions — as reflected by the decline in the unemployment rate to its historical low of 4.9% in July — provided support to wages and households’ disposable income growth.

However, from Q2 2021 to Q2 2022, the growth in compensation per employee did not exceed the increase in the cost of living. Consequently real — inflation-adjusted — disposable income per capita has been trending down.

Recent figures from Statistics Canada’s Labour Force Survey suggest that labour market conditions started easing. Employment declined in September from its peak last May (-0.5%), mostly from declining full-time employment. The unemployment rate rose to 5.2% in September from its July 2022 historical low, reflecting softening labour market conditions. These will deteriorate further. With consumer price inflation staying above nominal income growth until early 2024, further declines are expected in per capita real disposable income (see chart 2).

As for the monetary policy rate, mortgage rates are expected to increase further. We now predict that the conventional 5-year (fixed) mortgage rate will increase and peak at 6% in Q4 2022, a significant rise from its historical low of 3.2% in Q3 2021. Once the monetary policy rate starts declining as inflation converges back towards its 1-to-3% targeted range, this mortgage rate will decline and stabilize at 5.3% by the second half of 2024 (see chart 1).

Population growth in 2020 was significantly slowed by pandemic-related restrictions and their impact on immigration.

Population growth recovered close to its 2-decade average since then as these restrictions were relaxed. Between 2022 and 2024, we expect the population to continue growing and about 671,000 new households added.

Recent housing market developments and outlook

Housing markets in Canada performed strongly in 2020 and 2021 despite the pandemic-related economic downturn. Growth in housing demand was strong as workers in high-paid occupations were much less affected by the pandemic. A shift in preference towards larger properties from the growing need for telework and homeschooling also drove growth.

Housing demand was also supported by fewer spending opportunities — due to public health restrictions — which significantly increased savings and hence the resources available to purchase a property. Other contributors to housing demand include historically low mortgage rates and, since 2021, the recovery in population growth. It recovered to its pre-pandemic rate with the relaxation of pandemic-related border restrictions.

Robust growth in housing demand combined with Canada’s structural supply shortage and insufficient new listings to satisfy the demand on the resale market resulted in a sharp escalation in housing prices from Q2 2020 to Q1 2022. Over this period, the seasonally adjusted MLS® average price for Canada increased by about 53%. From Q2 2020 to Q1 2021, the increase was largely driven by a compositional shift towards larger and more expensive properties. However, this compositional effect partly reversed afterward, which slowed the increase in the average price despite the continued underlying strengthening in house prices.

With Canada’s MLS® average price reaching its historical high in Q1 2022, the monthly income-share of shelter costs associated with a property newly purchased at this price exceeded levels seen in 1990 (see chart 3). This was a period when the 5-year fixed mortgage rate was above 10%. This ownership affordability indicator worsened further in Q2 2022 as the rise in mortgage rates dominated the improvement from the decline in house prices.

We were already predicting housing market conditions to ease and house price growth to slow with the expected return to more balanced and sustainable conditions. But the higher-than-expected rise in interest rates and the resulting deterioration in economic and income conditions will continue to reduce housing demand in the coming quarters. At historical lows, ownership affordability for potential buyers will also weigh on housing demand (see chart 3).

From its historical peak of $770,812 in Q1 2022, the national average MLS® price should decline 14.3% by Q2 2023. On an average annual basis, we now predict this price to grow 2.6% in 2022 — compared to 21.3% in 2021 — and decline by 6.2% in 2023 (see chart 4). Canada’s house prices will resume their upward trend in the second half of 2023 as demand rises with the recovery in economic and income conditions and mortgage rates begin normalizing. This house price is predicted to grow by 2.1% in 2024.

The house price decline over Q2 2022 to Q2 2023 will be mitigated by rising demand from population growth, elevated construction costs and limited housing supply. Thereafter, normalizing interest rates, the rise in population and households’ income, along with insufficient growth in supply will continue to put upward pressures on prices and rents.

Higher mortgage rates and reduced household income will make it more challenging for renter households to access ownership and push others out of ownership. Given limited supply, pressure on rental markets — and rents — should increase, thereby worsening already challenging rental affordability conditions. In addition, the strong increase in the cost of living and the predicted decline in employment and income conditions will further accentuate affordability pressures for renters.

Housing supply developments and outlook

Over the period since mid-2020, housing starts rose significantly above their pre-COVID decade average levels with contributions from both multiple and single structures. From 2010 to 2019, housing starts averaged 201,000 units annually (at the seasonally adjusted annual rate) and this average jumped to 263,000 between Q3 2020 and Q4 2021. In the first half of this year, housing starts averaged about 254,000 units, still above their pre-pandemic average. We expect housing starts to decline to 244,000 in 2023. They will recover along with housing demand in 2024, reaching 270,000 units.

The high level of annual starts in recent years and predicted to continue into 2024 is welcomed as Canada must increase the housing supply to progress toward affordability for all Canadians. However, starts must sustainably increase given the estimated magnitude of the housing supply gap of nearly 2 million units as of 2021. This gap will grow to 3.5 million units by 2030 if past construction trends are maintained.