Capital Economics said the country’s housing investment boom is the biggest on record, but it fears “the housing bust over the next two years could cost as much as 3.5% of GDP”.
Based on affordability, it estimates Canadian residential property is overvalued by up to 40%, meaning its property bubble is “worse than the peak of the US housing bubble”.
The economists project Canada’s GDP growth will slow from 2.4% this year to “only” 1.2% in 2018.
“The strength of first-quarter GDP growth was principally due to big gains in household consumption and housing investment. More recently, however, home sales have slumped and a correction in house prices is coming. The slowdown in GDP growth will eventually prompt policymakers to loosen monetary policy,” Capital Economics said.
“Allowing for some income growth over the next several years, the price correction could be anywhere between 20% and 40%, with significant implications for consumption growth too.
“Although business confidence rose earlier this year, oil prices have since fallen back and drilling activity is slowing again. Energy and other commodity exports rose over the past year, but non-commodity exports stagnated.
“The improvement in global manufacturing over the past several months, however, suggests export growth overall should improve this year,” the firm said.
It added that the looming negotiations wth the US over the North American Free Trade Agreement “will be critical to the broader economic outlook” and it predicts “Canada will probably have to make some concessions, or risk the US unilaterally withdrawing”.
Capital Economics warns that the Canadian central bank has little power to influence house prices.
“We doubt the bank could do much to prevent a correction in the housing market and any negative knock-on effects to the wider economy, given that it has only limited scope to reduce interest rates,” it said.