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Canada’s economic growth remains solid


Canada’s economy is expected to grow by 2.8 per cent in the final half of 2007 and 2.5 per cent next year, according to the latest economic forecast from RBC.

“Despite recent financial market volatility, Canada should continue to sustain relatively solid economic growth for the rest of 2007 and into 2008,” said Craig Wright, vice-president and chief economist, RBC. “Strong consumer and business spending will more than offset ongoing export-related weakness resulting from slower U.S. growth and the high Canadian dollar.”

According to the RBC report, strong demand from emerging markets, such as China, has pushed prices higher for numerous natural resource products exported by Canada. As a result, Canada’s terms of trade - a measure of the movement in the price of Canadian exports relative to imports - has improved significantly between 2002 and mid-2007, increasing by roughly 20 per cent. Improving terms of trade means that Canadians are able to purchase more as its export earnings rise. Consequently, while growth in overall export volumes is weak, particularly to the U.S., prices for these natural resource exports have skyrocketed and are helping to lead Canada’s growth story.

As a result of the improved terms of trade along with the lowest unemployment rate in more than 30 years and solid wage gains, Canadians have seen their disposable incomes increase sharply over the past two and half years. This boost has helped fuel the pace of both consumer and business spending.

Inflation rates remain slightly above the mid-point of the Bank of Canada’s target rate. While this state would normally spur the central bank to raise interest rates, unstable financial markets and the unexpected strength of the Canadian dollar will likely delay a rate increase until 2008.

“The Canadian dollar appears likely to remain above parity through the end of the year,” said Wright. “However, moving into 2008, as financial market expectations shift away from further Fed easing and toward an increase in the Fed funds rate, the Canadian dollar will start to reverse recent gains. This weakening trend will be abetted by moderating commodity prices. We are forecasting that the currency will end 2008 at C$0.93/US$, which represents a 9.2 per cent depreciation compared to current levels.”

For the U.S., RBC has downgraded its economic forecast for the second half of this year to an average annualized quarterly growth rate slightly below 2.5 per cent due to the recent tightening of credit conditions and continued weakness in its housing market.

The U.S. economy grew on average by 2.2 per cent in the first half of 2007, with growth restrained by an ongoing housing market correction. Consumers started the year spending aggressively and, even though activity slowed in the second quarter, the sector remained a key support for the U.S. economy. RBC forecasts that consumer spending will average 2.5 per cent in the second half of 2007 and 2.4 per cent in 2008 - a key factor that will see the U.S. economy avoid a more serious slowdown even as the housing market correction enters its third year.

Investors’ continued reassessment of risk has created heightened downside exposure for the near-term U.S. economic outlook, placing pressure on the U.S. Federal Reserve to use all the tools in its arsenal to keep markets liquid. A 25-basis point reduction of the Fed funds rate is expected before the end of the year, to support the 50 basis point reduction on September 18. Once stability is restored, the Fed’s focus will return to inflation and rates will start to move back up late in 2008.


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