Canadian economy will struggle alongside the U.S. in 2008/09: TD Economics

    -   Canadian real GDP to post 1.0% gain in 2008, underperforming U.S.
        growth of 1.4%.
    -   Multitude of shocks hitting the U.S. economy leaves forecasters
        divided on the 2009 outlook.
    -   TD Economics is more aligned with pessimistic camp on U.S. outlook,
        expecting meager 1.2% growth in 2009.
    -   Canadian forecasters are in greater agreement with 2009 predictions.
        Most project reasonably solid domestic performances, so differences
        in forecasts are generally contained to that portion of the economy
        directly exposed to the United States - credit tightening and export
    -   Canadian economy should post modest 1.8% recovery in 2009, giving
        Canada the upper hand relative to the U.S. economic performance.

    TORONTO, June 18 /CNW/ - A report published today by TD Economics states
the Canadian economy is already showing signs of distress from the U.S.
economic downturn, and will continue to feel its affect throughout 2008 and
2009. Specifically, Canada has direct exposure to the U.S. housing fiasco via
the spillover of tightened credit conditions, and faces collateral damage to
the export sector from a stagnating U.S. economy. Fortunately, this is
occurring in an otherwise healthy domestic demand environment.
    According to Chief Economist, Don Drummond, "Canadians would be best
advised to buckle up for the ride." The path of the Canadian economy will be
greatly influenced by how the shocks surrounding oil, the credit crunch and
the plunging housing market evolve in the United States. TD Economics believes
the U.S. economy will not experience the snap-back that typically follows an
economic downturn. Rather, the number and severity of the shocks occurring
simultaneously in the economy argue for an extended period of economic

    Credit crunch to financial munch

    The greatest forecasting uncertainty centers around the credit crunch,
for which there is little historical precedence. TD Economics believes the
impact from tight credit conditions will linger on the U.S. economy, and weigh
down investment and consumer spending intentions through 2009.
    "When financial firms pay more or profit less in their lending activity,
the knock-on effects to non-financial firms and consumers can be quite long
lasting. The combination of rising lending rates, tightening credit conditions
and a dwindling share of internal funds available for investment spells
trouble," said Drummond. Credit problems of today can act as a financial
accelerator, whereby a shock is amplified or becomes long lasting by
restricting firms through swings in their balance sheets and spending

    U.S. consumers face a full frontal assault

    Mounting job losses will put downward pressure on household income in the
year to come. Meanwhile record deterioration in home prices alongside record
oil and gasoline prices makes for a less inviting environment for consumer
spending, especially now that the Federal Reserve is showing reluctance to
provide any additional monetary stimulus due to inflationary pressures.
    "Our belief is that instead of getting the traditional pent-up demand pop
in consumer spending that typically follows a downturn, we will see a muted
pace of spending through the end of 2009. The non-traditional number and
magnitude of economic shocks assaulting the consumer don't suggest a
traditional recovery," said Drummond.
    The U.S. government will be sending out $117 billion in rebate cheques,
which will boost real consumer spending by $60-70 billion annualized in each
of the second and third quarters. However, this is a one-time impact. Once the
cheques are spent, consumer spending will drop back to the status quo level,
which means a negative quarter. The short-lived tax rebate won't change the
view that annual growth in real personal income less government transfers will
still be treading water at -0.4% by the final quarter of this year and
remaining in the red through the first quarter of 2009.

    Canada to be pulled along with the ride

    Canadian exporters will continue to feel the pain from the lingering U.S.
economic weakness. Real GDP will expand at a 1.0% pace in 2008 and a 1.8% pace
in 2009. Both of these estimates are at the low end of consensus estimates
because of a more pessimistic U.S. outlook, and hence greater secondary
effects to the Canadian market. Meanwhile, domestic demand growth will gear
down in response to the tighter credit conditions and a softer job market.
    Specifically, like the U.S., the cost of funding has risen dramatically.
The Libor-OIS spread was blown out for Canadian banks following the credit
turmoil that began last August. The wound has been healing, but slowly. The
spread remained high at 20-40 basis points in June compared to a low and
steady 3-5 basis point range in prior years. A sharp increase in
medium-to-longer term funding costs has caused a tightening in credit
conditions on this side of the border, which will have knock-on effects to
investment and spending.
    However, Drummond noted one critical distinction between Canada and the
United States: "Canadians households have one good leg to stand on. They will
not have to face deterioration in real estate wealth or a sharp slowdown in
income growth. The same cannot be said of their American counterparts."
    In particular, Canadian employers continue to churn out new job
opportunities, providing a solid foundation beneath income growth. With five
months of employment data already on the books, the die has largely been cast
on this front. Employers have been averaging 24,000 new workers per month,
with hourly wage growth of permanent employees averaging 4.6% - the highest on
record since 1997. With inflation holding below 2%, workers have had the
benefit of a tidy real wage gain. Even with the expectation for softer job
creation in Canada going forward (averaging about 5,000 positions per month),
it will merely serve to restore wage growth to historical norms. As such,
consumer spending should prove more resilient in Canada, averaging a quarterly
annualized pace of 2.7% over the forecast horizon.
    Drummond also said that "Although inflationary pressures are the 'flavour
of the month' worrying financial market participants, we see the continued
weakness in the U.S. and Canada containing inflation pressures. Nevertheless,
the next move by both central banks will be to hike rates, but only after a
long pause." The Bank of Canada and Federal Reserve are both expected to begin
a tightening cycle in the second half of 2009.

    TD Economics' Quarterly Economic Forecast can be found at

For further information:

For further information: Don Drummond, Chief Economist and S.V.P., (416)
982-2556; Beata Caranci, Director of Economic Forecasting, (416) 982-8067;
Pour obtenir plus de renseignements, veuillez communiquer avec: Pascal
Gauthier, Economiste, (416) 944-5730

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