CANADA BENEFITING FROM STRONGER ECONOMIC PROSPECTS ABROAD, BUT MODERATION IN GROWTH STILL IN THE CARDS

TORONTO, March 16 /CNW/ - TD Economics today announced that it is revising its growth forecast to 3.0% for 2011, up from 2.6%, previously announced in its December TD Quarterly Economic Forecast. The upward revision reflects a brighter U.S. outlook, as well as an increased global appetite for Canadian commodities.

"Canada's economy has entered 2011 on a stronger footing than was envisioned at the time of our last quarterly forecast in December," said Craig Alexander Chief Economist for TD Bank Group. "Beyond the near term, however, our view has not materially changed. Over the next 12-18 months, the overall pace of the Canadian economic expansion is likely to moderate, as interest rates rise and domestic spending cools." While the tragedy in Japan is still unfolding and creating untold human hardship, TD Economics does not expect it to have a meaningful impact on the Canadian economy.

Solid momentum heading into the New Year

The recent release of fourth-quarter data revealed that Canada's economy finished 2010 on a surprisingly strong note, with an advance in real GDP of 3.3% (annualized) following an upwardly-revised 1.8% expansion in the prior period. While consumers turned in another formidable showing in the final quarter, much of the strength was attributable to net exports, which alone contributed a stunning 4.5 percentage points to economic growth - the largest contribution from net trade since the early 2000s. At the same time, business inventories were drawn down in the quarter, suggesting the surge in demand from the U.S. and Canadian consumers was largely unanticipated.

The reduction in inventories bodes well for the near-term performance. "Depressed inventory levels suggest that businesses will need to rebuild inventories to keep up with the expected future pace of sales, particularly at a time when the U.S. recovery is becoming more fully entrenched," added Alexander. The first half of 2011 is likely to see further advances in the United States' road back to economic health, with an average expansion of about 3.3% (annualized) in real GDP. "Despite facing the ongoing challenge of a currency hovering around parity, export-oriented industries, such as automotive and other key manufacturing industries, appear poised to ramp up production in the coming quarters," observes Alexander.

Prospects for resource exports also remain relatively bright. Although prices for key commodities may be prone to a moderate pull-back in the near term, as demand is disrupted in earthquake-ravaged Japan and monetary authorities in China and other emerging markets work to fight against inflation risks, prices will remain supportive to national income growth. Our outlook assumes that oil prices will average US$95-100 per barrel throughout this year and next, which at that level would deliver a modest net benefit to Canada's overall economy. "There is a significant geopolitical risk in the premium of oil prices at the moment. Markets have priced in a supply disruption beyond just Libya, but crude oil prices will fall if that does not materialize," notes Alexander. "However, given the high level of uncertainty around how Middle Eastern developments will unfold, crude oil prices remain a wild card for the outlook."

Housing demand to cool

In combination with tougher mortgage insurance regulation, rising interest rates will also dampen demand in the Canadian resale housing market in the second half of 2011 and through 2012. The new mortgage insurance rules come into effect mid-March and will increase the average monthly cost of carrying an insured mortgage. As was the case the last time the Federal government made mortgage insurance regulations more restrictive, the recent strength will likely be followed by a period of weak housing data once the tougher rules are put into effect.

"We continue to believe that given underlying economic fundamentals, the Canadian housing market will remain well balanced through the forecast horizon, and home prices will mostly move sideways. This is a significant change from the 10% average annual price gains experienced over the last decade," Alexander said.

The business sector to take the growth mantle

As the household and government engines downshift, the heavy lifting will increasingly come from business investment and exports over the 2011-12 period. Risks to the U.S. recovery have declined and there is a strong possibility that the lagging U.S. job market will begin to record a meaningful improvement in the months ahead.

The strong momentum in U.S.-bound shipments of Canadian manufactured goods, such as automobiles and industrial goods, is likely to extend through the 2011-12 forecast period, despite a Canadian dollar that will average above parity this year and close to parity next year. Moreover, Canada has a competitive advantage in the commodity sector, and continued strong, albeit somewhat more moderate, growth in developing economies will continue to fuel global appetite for Canadian commodities.

Domestic and global risks continue to linger

Despite the growing confidence in Canada regarding the recovery, there is no shortage of risks that could materialize over the next few years and negatively impact the economic path. Some of these risks are domestic in nature, such as high household indebtedness and concerns about excessive valuation in housing markets.

Many risks remain of a global sort. Rising inflation in emerging markets raises the spectra of a boom-bust cycle which would wreak havoc on commodity markets. A spreading in Middle Eastern unrest to the largest oil producers in the region would lead to a spike in the price of crude that could drive the value of the Canadian dollar up further and/or trigger a global recession. Europe remains a potential trouble spot, with its government fiscal problems that could lead to one or more debt restructurings in the region, which could in turn impact the European banking system. And while the U.S. recovery is looking stronger, it remains heavily reliant on monetary and fiscal stimulus. What's more, ongoing massive U.S. fiscal imbalances increase the possibility of financial market turbulence.

A solid year ahead

The base case outlook is for solid Canadian economic growth of 3.0% in 2011, followed by a slowdown to 2.5% in 2012. This pace of expansion will not create an inflation problem, and there is likely to be limited pass-through to other consumer prices from high energy costs. It will support moderate job creation and double digit profit growth in 2011 and high single digit profit growth in 2012. Given this backdrop, interest rates will rise only gradually, with the Bank of Canada hiking rates by 1 percentage point in the second half of this year and another percentage point next year. "Despite the risk-filled environment, the most likely outcome is a continued healthy performance by the Canadian economy in 2011 and 2012," concluded Alexander.