Blue Book: 2021 Ontario Outlook

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Ontario at dusk. Click here to play video.

Robert Kavcic | March 31, 2021 | Economic Insights

Robert Kavcic | March 31, 2021 | Economic Insights

BMO recently held a virtual event to provide an in-depth discussion of the annual Blue Book. Douglas Porter, BMO Financial Group’s Chief Economist, provided an overview of the macroeconomic indicators across Canada, while I discussed the provincial economic trends.

After a tough 2020, Ontario’s economy is projected to grow right in line with the 5% rebound expected across Canada. Unemployment is expected to remain above the national level, with sectors such as travel, entertainment and dining hit particularly hard by the pandemic.

But housing markets across the province are exceptionally strong, especially outside the Greater Toronto area. All told, a tough start to the year should give way to a stronger recovery later in the year.

In total, while the fiscal landscape presents some challenges, sturdy U.S. demand and a competitive Canadian dollar work in Ontario’s favour in 2021.

Read the entire Blue Book here.

Transcript

Robert Kavcic:

Great. Thanks a lot, Doug. Again, thanks, everybody, for joining us today. What I'm going to do is I'm going to focus in a little bit more on three topics, in particular: the labor market, the housing market, and what's happening with fiscal policy. I'm going to do so with an eye specifically on what's happening here in Ontario. Of course, those are pretty massive topics right now, so I will do the best as I can in the time allotted, then, of course, we will have some time still coming for Q&A at the end.

First of all, I'll just take a quick look at our growth forecast. One of the points Doug made was that the global economy across the board has been dealing with the pandemic. You can say the same thing at the provincial level in Canada. Every single province in Canada saw a historically deep contraction in 2020. The flip side is that every province in Canada is setting up or seeing a rebound underway at the moment, and we expect that to look very strong across Canada this year and into 2022.

Looking at Ontario specifically, last year was tougher than average. We saw the economy contract almost 6%. This year, we are looking for a near 6% rebound with a little bit of a slower start than some of the others just because some of the COVID-related restrictions were slower to come off first of all in parts of Ontario, but specifically, in the GTA. We are just starting to see some of those measures rolled back now.

The handoff was a little bit slower to get started, but we do think that the second half of this year in Ontario is going to look exceptionally strong, and then by 2022, this province does have the potential to actually lead the country in economic growth.

Partly because we are coming out of a bigger hole than some of the others like British Columbia for an example, but also partly because even pre-COVID, Ontario along with Quebec and British Columbia, was really the driver of economic growth in this country. We do think that is a longer-term trend that is going to reassert itself going forward. That's where we are with respect to growth.

If we look into the labor market, what we can see here is that, yes, again, every province in Canada felt a very significant shock to the job market. Ontario's jobless rate pushed up to almost 14% at one point. It has more or less tracked the national average down as it tends to do just being the largest province in Canada. But what we can see here is, in terms of the number of job losses relative to where we were pre-COVID, Ontario is still lagging pretty deeply.

From a year ago, you can see here that Ontario is at the bottom of the pack in terms of the year-over-year job decline. Again, that really does relate to still big declines in particular service industries that were really held back by COVID-related restrictions, and as of January, had not fully come off yet. I suspect in the next, even just two or three months of data, that Ontario is going to start to quickly move up the leaderboard here as those jobs come back online.

If we drill below the surface a little bit more, the GTA region being obviously the big urban center has been hit a little bit harder. Toronto employment, for example, is down about 4.2% from last February. The rest of Ontario, if you strip out Toronto, is down a little bit more modestly, about 3.7%, 3.8%. Still, obviously, impacted, but the hit to things like entertainment and recreation and restaurants was obviously felt more acutely in the core of the GTA than some of the smaller cities around the remainder of the province.

Drilling a little bit further into the labor market, this chart tells a couple of stories here. What you're looking at here is various industries in Canada and how their employment performance has looked relative to last February, just before we went into the pandemic.

As you go left to right along this chart, you see better employment outcomes. Accommodation and food services, for example, on the far left side, that industry is still down more than 30% from where we were last February.

Information, culture, recreation, all of these face-to-face service entertainment restaurant-type industries are the ones where really the biggest job hole is still persisting in Canada.

What's interesting, though, is as you push further to the right and you go past that vertical bar, those are industries that have already fully recovered from last February. Things like professional services, scientific services, higher-tech type jobs, finance, we're all working remotely today. Those industries very quickly were able to come back and recover the pandemic losses. You're starting to see this fractured labor market with respect to how quickly the recovery has been.

The other key takeaway here is, if you look on the vertical axis, as you go from the bottom to the top on this chart, you move up the pay scale. What you can take away here is that the biggest employment declines that are still persistent today are in more or less the lower-paying industries in Canada.

In fact, if you pull out just the five or six strongest industries with respect to employment, they also just happen to be the five or six highest paying industries in Canada. Again, you have this fracturing of the labor market, where if you were in a higher-paying white-collar type of job, even areas of construction and manufacturing, you've actually done relatively well. It's the lower-paying service industries where the real drag has been on the job market.

I use that to cue up the story on the housing market, which I'm sure everyone is deeply interested in right now, given what's happening across this province. Because we are seeing record sales levels, we are seeing price growth accelerate well into the double digits. That's being polite. In reality, we've seen 20% to 30% price gains from a year ago.

In some smaller, more rural markets, not exaggerating, we've seen prices level up as much as 40% from where we were last February when the pandemic was just starting out. I'll try and give you an idea of what's going on here in the limited amount of time that I have, but a couple of factors are really pushing out the demand curve for housing across Ontario. I'm not talking just Toronto, specifically, but markets one to two hours outside the core of Toronto.

The first one is on the employment and the income side. The head scratch early on was, how can the housing market be recovering so quickly and so strongly when we still have almost-- At one point, we did have double-digit unemployment which typically does not correlate well with a very strong housing market. But as we showed in that last chart, when you dig below the surface a little bit, what you see is that the higher-paying industries actually did see job growth come back very quickly. Of course, it's those higher-paying industries that provide the vast majority of marginal new homebuyers, as opposed to the lower end of the income scale, where you see a lot more of a renting population. Younger workers, for example, part-time workers, those are not typically drivers of resale housing demand.

That has helped to drive a very strong recovery for sure, as has, historically, strong federal to household transfer payments. In fact, when you look at household disposable income, through this pandemic, we've actually really seen the only recession in history where household incomes have actually risen, partly because of the strong rebound in higher-paying employment, but also because of massive federal transfers. That has helped the demand for homes.

You layer on to that record low five-year fixed-rate mortgages, which were bouncing around 1.5% to 1.7%, depending on the borrower, historically low. Now, that said, those rates have started to nudge up a little bit, but still a very favorable financing environment here in Canada.

Then probably the biggest factor is that preferences have shifted very dramatically during the pandemic. If you go back over the last 10 or 15 years, we had this persistent shift of strength into the core of the GTA, from an employment perspective, from a housing demand perspective. As soon as the pandemic hit, we saw those flows turn right around and head the other way.

We do have data on migration flows within the province that are, unfortunately, not very timely, but they do show pretty clearly that through the first half of this year, there was, in fact, an accelerated movement of people outside the core of the GTA into other markets across Ontario.

In fact, if you add up the major centers like Vancouver, Montreal, and Toronto, I think their running tally over the last 12 months through the middle of 2020 was about 88,000 people. Pretty, clearly, that has been accelerating over the course of the remainder of 2020. That's driving very strong demand for markets across other regions of Ontario.

The recreational property market has been absolutely on fire as well. If you think about it, a lot of households have a lot of equity built up in their home in, say, the Toronto area, which has performed extremely well over the last decade. They also have nowhere to go right now. They can't travel, a lot of recreation is shut down. What have they been doing over the last year? They've been aggressively purchasing recreational properties. I'm not talking just your typical cottage country properties, which are, again, historically strong and historically tight, but even rural properties and farm properties or properties in smaller towns maybe perhaps closer to family and stuff like that.

That is where this strength is coming from. At the same time, we're very tightly supplied on this type of housing inventory. That's how we got here.

Where we go from here is the next question. To be honest, with Doug's outlook on the Bank of Canada, not moving interest rates anytime over the next two years and with perhaps the longer end of the yield curve, maybe starting to steadily settle down a bit. Yes, we're going to see a bit of a nudge up in mortgage rates, but is it going to be enough to cool this demand? I would suspect not.

I suspect that the next six months to a year still look extremely strong for housing markets around the GTA, perhaps concerningly strong if this starts to reinforce itself into more speculative activity. That's something we'll be mindful of going forward over the next year or so.

Longer-term, the thing I would say here is that this shift out of the GTA into the suburbs, into single detached homes and some of the smaller markets was probably something that was going to happen anyway, over a longer period of time, just given that we have a huge bulge in the population that is the leading edge of which is about 38 to 40 years old right now.

Contrary to what they might have been telling you, young families, when they have their second or third kid, they typically don't want to raise them in condos. They want space. Over the next decade, I firmly believe that this is something we were going to see anyway. As we've seen with a lot of other things, the pandemic had this ability to pull 5 or 10 years worth of future trends forward and compress it into a very small window.

The flip side of that is, "Well, okay, if the pandemic actually does get out of our way, then maybe we've borrowed some of the strength from the future and as we get into 2022 and beyond, if interest rates do backup and some of this demand has been pulled forward, those markets then should, in theory, soften and maybe probably stagnate for a couple of years beyond. In the near term, it's strength upon strength.

I'll shift over to fiscal policy a little bit here. First of all, just a quick look at how the different provinces rank from a fiscal perspective. As you go up this chart, you see a higher deficit as a share of GDP. As you go out, left to right on this chart, you see higher debt as a share of GDP. Obviously, where you want to be on this is down in the bottom left corner. As you go up into the right, you get worse and worse and worse.

Not to pick on Ontario, but you can see where they sit on this chart, somewhere in between Quebec and Newfoundland. All provinces on this chart, to be fair, have moved up into the right pretty significantly over the past year.

The thing I would say with Ontario just very quickly is that we're looking at a deficit of about $38 billion. Today, it's 4.5% of GDP. It's substantial. I do think that there are conservative assumptions built into the fiscal plan right now and we're going to get a budget, I believe, on March 24th, in Ontario.

I suspect that we have already seen the peak in terms of the size of the deficit here. Maybe even if we look out over the next two or three years, the downward momentum in the deficit might actually be a little bit quicker, than the province has on the books right now.

More importantly, though, I think, even as all these provinces have shifted up into the right, so to speak on this chart, the reality is that it could have been a whole lot worse. It wasn't because Ottawa stepped in and did the vast majority of the spending through the pandemic.

We have seen about $275 billion or so of direct fiscal support from Ottawa transfer down to households and to businesses. The concept here was to get money out the door fast and very widely and in bulk, so that when policymakers come and say, "Okay, let's reopen businesses, and let's get back to work," that there are actually, still are businesses there to come turn the lights back on. Liquidity and solvency effectively, here, is what they were trying to preserve.

The consequence of that is, we're looking at a deficit that's pushing above $380 billion now, and as a share of GDP, that's 17.5%. It makes Ontario look actually pretty decent down at 4.5%. It just highlights how the federal government, probably rightly so, did absorb the vast majority of the cost associated with the pandemic. There is going to be some payback for this going forward, of course. That's one of the biggest questions we get.

I think, to be honest, a lot of the work can be done on its own. We're not sitting here expecting a big wave of tax increases in this year's budget whenever we do get it. Just by sitting still and letting the economy recover as strongly as we suspect that it will and by letting some of these programs naturally roll off rather than extending them time after time when the economy might not need it anymore.

Even by just not using another $70 to $100 billion worth of fiscal stimulus that is being talked about right now, very quickly, you can see on this chart that the deficit can come down pretty significantly and get us back into 5%, 6%, or 7% of GDP range that is quite a bit more comfortable than where we are today.

A couple of other points on here that maybe help alleviate the stress a little bit. One is that, remember, everybody was in this together. We have seen major governments around the developed world see pretty big fiscal holes develop. Yes, Canada was a little bit more aggressive on the stimulus and maybe the relative deterioration was bigger. Canada also came into this in, arguably, one of the better fiscal positions in the developed world from a debt perspective.

On debt, specifically, as much as we are borrowing today, we are doing it at a rate that costs us about 7￠ or 8￠ on the dollar of revenue for the federal government. Go back to the 1990s when we had a real fiscal problem here, Ottawa was paying about 35￠ on the dollar to service debt.

From that perspective, we are made a little bit more comfortable, but understanding the reality here that that deficit is obviously going to have to come down pretty quickly over the course of the next couple of years. The lingering question is just exactly how much of that is going to be the economy acting on its own, and potentially, any other measures that come with that.

I'll just wrap it up here with a quick summary on what we are looking at for Ontario. As Doug mentioned, the recovery in the US economy and the persistent upward revisions we're seeing there is far and away one of the most positive drivers of economic activity in Ontario. It's direct and it's a very, very strong link. If we are bullish on the US as we are, by rule, we shouldn't be bullish on Ontario, which we are.

The demographics here are quite strong as well. Yes, we are going through a bit of a wall in terms of population growth now, obviously, because of the nature of the pandemic, but Ottawa has been pretty steadfast in sticking to its immigration targets as we come out of the pandemic. That's supportive as well.

Plus, if you look outside the GTA, one of the big reasons why we have seen this exodus from the city is simply because market's one to two hours outside the core of Toronto. London, Windsor is a little bit further but Londons, Woodstocks, the Barries, Peterboroughs, those markets, on an affordability basis, look extremely attractive. Hence why the decision was quite easy for a lot of households to say, "You know what? This is the time, let's pack up and get out of Toronto."

Some of this is going to stick with us going forward. As I said, I think some of this was activity that was going to happen anyway and got pulled forward. I don't think we're going to completely unwind what we've seen over the last year, but I do think that at the end of the day, markets in some of these smaller cities are running a little bit hot and we're probably going to give some of it back at some point. The GTA specifically is going to continue to be a very strong job creator and a draw for most households and new immigrants coming into Canada as well.

The reality is that we probably settle somewhere in between, but I do expect Toronto to, in fact, come back. I will leave it at that. I'm sure there are questions out there. I'm happy to pause here and see what the questions look like.

Robert Kavcic

Director and Senior Economist

Robert has been with the Bank of Montreal since 2006. He plays a key role in analyzing economic, fiscal and real estate trends in Canada. Robert regularly contribut…(..)

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In total, while the fiscal landscape presents some challenges, sturdy U.S. demand and a competitive Canadian dollar work in Ontario’s favour in 2021.

Read the entire Blue Book here.

This is part 5 of a 7-part series on

Blue Book: 2021 Ontario Outlook

PART 1