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- Canada's economic growth to soften, but economic expansion will continue - Canadian dollar to remain close to, or slightly above, parity over the next six months - U.S. economic slowdown to persist through 2008, but a recession unlikely - Combination of strong loonie and U.S. weakness will hamper selected Canadian industries, including: manufacturing, tourism and hospitality - Domestic Canadian economy and Canadian real estate markets will remain solid - Canadian real GDP is expected to average 2.4 percent in second half of 2007 and 2.3 percent in 2008 TORONTO, Oct. 4 /CNW/ - In the wake of the financial volatility in August and the continued problems in some areas, such as the asset-backed commercial paper market in Canada, there have been increased concerns about the North American economic outlook. However, the Canadian economy will weather the fallout from the financial turmoil, although it will be dampened by the impact of a stronger Canadian dollar and weaker U.S. economy, according to the October issue of the TD Quarterly Economic Forecast. "It's easy to be pessimistic on the U.S. economy at the moment, given that the weakness in the housing market is far from over and lenders will likely cut back on the availability of credit in the near term," noted TD's Deputy Chief Economist Craig Alexander. However, the TD Economics forecast for U.S. economic growth is little changed, with 2 percent anticipated in 2007 and 2.4 percent in 2008. "Prior to the financial volatility in August, a significant slowdown in consumer spending was anticipated. Recent events simply make this more likely to occur," observed Alexander. The key is what happens in U.S. labour markets. TD Economics expects job creation to slow, but the unemployment rate should only edge up for its current low level, with the result that personal income will rise faster than prices. "Americans may scale back their spending on big ticket items - like autos and luxury items - but so long as people have jobs and real earnings continue to grow, the economic expansion will continue," said Alexander. Businesses may also tighten their belts and some corporations may have difficulties raising new capital in the near term, which could dampen business investment. However, they are generally in good financial shape to ride out the challenges. Export growth will also help to keep the U.S. economy's head above water, with shipments receiving a lift from a strong global economy and a weaker U.S. dollar. "The U.S. Federal Reserve has acted pre-emptively to offset some of the future economic fallout, using a wide range of tools and ultimately easing monetary policy," said Alexander. "However, it does not want to send a message that there is a bailout available. This limits how far the central bank will be willing to lower rates and it is why we believe it will only cut by a further quarter point in late October. The implication is that financial markets are overestimating how far rates will fall." In Canada, the recent financial turmoil will have an impact, but the effect should be limited. The on-going problems in the asset-back commercial paper market may constrain borrowing in the near term and may have a dampening impact on the economy, but the effect should be limited and it is expected to pass over the next couple of months. "There is no reason for Canadian lenders to tighten their credit standards in a significant way, since they were never loosened like in the United States," remarked Alexander. For instance, the subprime mortgage market in Canada was roughly 5 percent of mortgage originations in 2006, compared to 25 percent south of the border. However the recent financial volatility will have an indirect impact on the domestic economy. Demand for Canadian products will soften alongside the weaker performing U.S. economy. The U.S. is currently the destination for 76 percent of Canadian exports, which represent about 24 percent of Canadian real GDP. The waning U.S. demand will be compounded by the rise in the Canadian dollar, which reached parity in September. Looking forward, the Canadian dollar is expected to average close to, or slightly above, parity over the next six months, but then trend down towards 95 U.S. cents by the end of 2008. The appreciation in the Canadian dollar since the last fixed announcement date and the recent weaker U.S. economic data suggest that the Bank of Canada will stay on the sidelines on October 16th, but the risk of inflation remains, suggesting that the next move by the Bank is still likely a hike. Ultimately, Canada's economic foundation is sound. The report points to a number of factors including: - The economy had good momentum heading into the financial turmoil. - The unemployment rate is at a 33-year low and tight labour market conditions are fueling robust personal income growth. - Corporate balance sheets are in great shape, which is a potential positive for business investment growth. - Government fiscal balances, at both the federal and provincial levels, are the envy of the industrial world, enabling policy makers the flexibility to respond to any severe economic challenges that could arise. The Canadian housing market remains strong. "We do not believe that there is a bubble in Canadian real estate, as prices and sales growth have been driven by economic fundamentals, not speculation or inappropriate lending behaviour that characterized the U.S. experience," noted Alexander. The introduction of 35- and 40-year amortization mortgages has 'thrown fuel on the fire' by temporarily improving affordability, but housing markets should cool once the impact of these new financial products wanes. "Although the outlook is for continued growth in the North American economy, we are not dismissive about the downside risks. The odds of a U.S. recession are probably close to one-in-three, the highest since the tech bubble burst at the start of this decade," said Alexander. If the U.S. outlook proves to be too rosy, then so is the perspective on the Canadian economy. The key vulnerabilities relate to the U.S. consumer, and this means close scrutiny is called for with respect to data releases on employment, income, spending and personal borrowing. However, Alexander stresses that, "the Canadian economic fundamentals have never been in a better position to ride out any economic challenges that might be in the cards." For further information: Craig Alexander, VP & Deputy Chief Economist, (416) 982-8064; Beata Caranci, Director of Economic Forecasting, (416) 982-8067

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