Canada will weather financial storm: TD Quarterly Economic Forecast

    -   Canada's economic growth to soften, but economic expansion will
    -   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
    -   Combination of strong loonie and U.S. weakness will hamper selected
        Canadian industries, including: manufacturing, tourism and
    -   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.
    "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:

For further information: Craig Alexander, VP & Deputy Chief Economist,
(416) 982-8064; Beata Caranci, Director of Economic Forecasting, (416)

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