Irrational exuberance, Canadian style

True story: sitting in a doctor's waiting room last week, I spotted a headline on a the front cover of Canadian Business magazine: "The housing collapse begins". I picked the magazine up and started to read about how the market in Vancouver was starting to implode, with Toronto soon to follow.  All kinds of economists weighed in on how this was the beginning of the end for the overvalued Canadian housing sector.

Then something struck me as being amiss, and I looked at the date on the cover: October 2012! Truth is, despite the big-print headline and all those confident economists' prognostications, that collapse never actually happened. Indeed, in the two markets identified all those months ago as being closest to the edge -- Vancouver and Toronto -- home prices have gone ever higher, outpacing the rest of the country.

It seems more than likely that the divergence in performance between those two cities and the rest of  Canada will continue for a while yet. Although the latest national home price data show that prices nationwide are up by a bit more than 3 percent year-on-year, that number is entirely based on strong advances in Toronto and Vancouver.  Excluding those cities, prices are actually slightly lower than at this time last year. Moreover, sales activity is slipping, with particular weakness seen in Calgary and Edmonton as the impact of falling oil prices starts to be felt in the producing provinces. A surge in new sales listings in Calgary points to further price declines in the coming months.

What does this mean for Bank of Canada policy? Business economists, who to a man and woman failed to predict the Bank's rate reduction in January, are now confident that it will cut rates again in March.  And they may well be right, but I have yet to hear a convincing explanation of why the Bank thinks that further monetary easing is helpful.

As long as oil prices stay depressed, the housing market in Alberta (and Saskatchewan and Newfoundland) will not recover, regardless of where borrowing costs go. At the same time, the markets in Toronto and Vancouver, which even scarily complacent Bank of Canada Governor Stephen Poloz admits are seriously overvalued, will continue to race ahead to even more unsustainable levels. In fact, as this article reports, that's already happening in the Toronto region.

It's getting harder and harder to see a happy ending to this story. The Canadian economy is looking anaemic compared to its neighbour to the south, and the fact that the Alberta housing market has been walloped so quickly by the fall in oil prices provides a clear warning of what could happen elsewhere in the country in the event of an adverse shock.  Expectations that the housing bubble in Toronto and Vancouver can be gently deflated, which never did seem altogether realistic, are dwindling even further as the Bank continues to pump more air into the bubble. It would be no exaggeration to say that the market in those cities is displaying irrational exuberance -- and we know how that plays out.