According to yesterday’s data release, U.S. housing starts remained low in February 2008, at 1.065 million units. This was about the same level as the revised figure for January (1.071 million units), but was slightly ahead of the lowest monthly number so far in this cycle, which was a revised December 2007 figure of exactly 1.000 million units.

Completions continue to be considerably higher than starts. This means that the inventory of unsold units will continue to rise. Just about the only good news is that completions are coming down month to month (-8.8% for “total” and -9.4% for “singles”). This is a necessary prelude to an eventual pickup in starts.

In the meantime, however, building permits (an advance indicator of starts) stayed depressed. In fact, both total residential building permits and single-family permits were below starts in the latest month.

Problems in the U.S. housing sector have spread into the banking sector by way of a liquidity crunch. The Federal Reserve is trying its hardest to avert more serious trouble. It is throwing “everything but the kitchen sink” at the problem. This included the help it provided last weekend in the sale of Bear Stearns Cos. to JPMorgan Chase. Another key component of the Fed’s strategy, since the subprime mortgage crisis first appeared in late summer of last year, has been to lower interest rates aggressively.

Therefore, also yesterday, the Federal Reserve announced a further 75 basis-point cut (100 basis points = 1.0%) in the federal funds rate. This leaves the Fed’s key policy-setting interest rate at only 2.25% and marks a decline of 300 basis points since last August. The lower interest rate is designed to stimulate economic activity and thereby restore confidence in the financial sector. However, lower rates also perform another important function. They make loan rollovers (including end-of-term changes to adjustable rate mortgages) cheaper.

The Bank of Canada (BOC) is watching the U.S. economy and world financial markets closely. The BOC has been much more cautious in its interest rate policy, with only a 100-basis point cut so far in total. On the other hand, Canada has a luxury that the U.S. does not. Inflation in Canada is running at a quite modest level. (The U.S. has set aside any inflation concerns to deal with a more immediate situation.) The February Consumer Price Index (CPI) number for Canada was released yesterday as well. The year-over-year “all-items” inflation rate in Canada (often referred to as the “headline” inflation rate) is only 1.8%. Core inflation is even less at 1.5%.

Low inflation in Canada is partly a result of Canadian dollar strength, which makes imports cheaper. The low inflation performance gives the BOC the option to lower interest rates in big steps along with the U.S. (please see an earlier blog entry). This would serve two purposes. It would help to forestall the negative spillover impacts of the U.S. slowdown/recession and it would take pressure off the Canadian dollar. The latter effect is needed to preserve manufacturing jobs that are dependent on exports to the U.S.

Alex Carrick

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