House Prices and Growth in North America

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The two largest economies in North America began 2005 at a healthy pace: in the first quarter of this year the US economy expanded by 3.7 per cent on an annual basis, while Canada's GDP grew by 3 1/4 per cent. US growth continued to decelerate, with the most recent quarter being the fourth consecutive decline in growth since the first quarter of 2004. A slowdown in Mexico, where growth slowed from a solid 4.9 per cent per annum in the final quarter of last year to just above 2.4 per cent in the first quarter of 2005, contributed to a relatively soft outcome for NAFTA growth in the opening quarter of this year, as compared to 2004. We expect growth in North America to decelerate by about 1/2 percentage point from the rate recorded in 2004, to about 3.7 per cent per annum in 2005 and 2006.

As has been the case for some time, GDP growth in the region's largest economies is driven primarily by domestic demand. Supported by strong income growth, rapidly rising house prices and surprisingly low inflation, private consumption expanded briskly in the first quarter of this year. It increased by 3.6 per cent per annum in the US and by over 3.9 per cent in Canada. Business investment was also a significant contributor to growth: it increased by 10.9 per cent on an annual basis in the US. This marked the fifth consecutive quarter of double digit growth. In Canada, business investment expanded by a healthy 8 1/4 per cent, the fastest pace of growth in a year. We continue to expect strong growth in domestic demand in both countries and forecast that US consumption will expand by about 3 1/2 per cent this year, slowing slightly to 3 per cent growth in 2006. Private consumption in Canada is expected to grow by 4 per cent this year, decelerating to a more sustainable 3 per cent growth rate in 2006. While we expect housing investment to slow somewhat in both countries, it is forecast to be a significant contributor to domestic demand, rising by about 4 per cent this year in Canada and by over 7 per cent in the US. US housing investment is discussed in more detail in the box. Reinforced by government spending, overall domestic demand is expected to grow briskly in both countries, both this year and into the medium term.

Driven by currency fluctuations on the one hand and sharp commodity price changes on the other hand, the external sector has started the year poorly in both the US and in Canada. Weak exports have affected US manufacturing. The Institute for Supply Management's monthly survey of manufacturing index was down to 51.4 in May from 62.6 a year ago--the sixth consecutive drop and the lowest reading since June 2003. In further confirmation of a slowdown, industrial production growth slowed from nearly 5 per cent per annum in the second quarter of last year to 3 3/4 per cent in the first quarter of 2005, with a further slowdown anticipated. In the meantime, strong private consumption supports robust growth of imports, which rose by 9.5 per cent on an annual basis in the first quarter of 2005.

Canadian exports appear to be in a period of adjustment to the stronger Canadian dollar, which appreciated significantly against the US dollar in 2004. As a result, exports grew by only 4.4 per cent per annum in the first quarter of this year, while imports, boosted by strong consumer demand and relatively low prices, expanded by 10.7 per cent on an annual basis. As a result, Canada's current account surplus shrank to 1.2 per cent of GDP in the first quarter of this year, down from the 3 per cent recorded just 4 quarters ago. Preliminary data for the first two months of the second quarter do not suggest a material improvement in export volume growth. We therefore expect Canadian GDP growth to be carried by the strength of domestic demand this year and next.

United States

US business investment has been growing strongly since 2003. Despite double digit growth rates, however, US private investment recovered its levels last seen in 2000 only in the third quarter of last year. …