Canada expected to follow US as economy slows

The mighty U.S. economy is slowing again, and with it Canada’s chances of escaping the global downdraft.

A sudden plunge Friday in a closely watched index of consumer confidence is the latest clue the recovery has stalled in the U.S., Canada’s neighbour and largest trading partner.

Economists warn that Canadian businesses and investors should brace for the inevitable spillover as the U.S. grapples with a slowing economy and a growing fiscal hangover from years of excess.

Canada will still fair relatively better than the United States. But a slowdown in manufacturing and consumer spending here is now likely, and an uptick in unemployment and even some months of shrinking economic activity is not out of the question, argued David Rosenberg, chief economist and strategist at Gluskin Sheff & Associates Inc. in Toronto.

"There isn’t even a debate: the Canadian economy is moderating," Mr. Rosenberg insisted.

"We’re going to move in the same general direction [as the United States]."

Most disturbing for Canada is that the housing boom is rapidly cooling.

And that will affect jobs, retail spending and manufacturing as homeowners build and buy less in the months ahead.

"The stock market is priced for peak profits next year," Mr. Rosenberg said. "People are going to be in for a rude surprise."

Consumers are also in for a shock as interest rates return to more normal levels. Next Tuesday, the Bank of Canada is widely expected to hike its key lending rate Tuesday for the second time this year – by a quarter percentage-point to 0.75 per cent.

Conference Board of Canada economist Pedro Antunes pointed out that Canadians have been spending at a faster rate than their incomes are growing, and that’s unsustainable.

"We’ve out-consumed our incomes," he said, adding that higher rates will put a lot of pressure on heavily indebted consumers.

Most forecasters are expecting the second half of the year to be significantly weaker than the first, when it looked like Canada had left the recession in the rear-view mirror. Just how much slower remains an open question. Earlier this week, the Conference Board said that while it’s still looking for the economy to grow by 3.6 per cent this year, the bulk of that expansion has already occurred. The rest of the year and 2011 will be markedly slower, largely because of what’s happening in the U.S., according to the Conference Board, an economic research group.

Moderation and slower growth doesn’t mean a double-dip recession in Canada. And most economists expect the country to continue to outperform the United States in most areas.

"We’re not calling for a double-dip by any means," said Bank of Montreal economist Sal Guatieri.

The Bank of Montreal, for example, is forecasting that Canada will grow at a rate of just 2 per cent in the second quarter, down from 6.1 per cent in the first quarter and an expected 2.7 per cent in the April to June period. Unlike the Conference Board, it’s calling for plus-three per cent growth in 2011.

Hanging over the longer-term outlook is the prospect of an extended period of national austerity in the United States – for both consumers and governments. The U.S. government faces a historic debt burden, and virtually all state and local government are scrambling to cut costs and raise taxes to deal with swelling budget shortfalls. That means Americans will have less disposable income to buy all the things that Canadian manufacturers now export to the U.S., including cars, parts and machinery.

BMO’s Mr. Guatieri said Canadian companies can’t continue hiring the way they have in recent months. Canada has already recouped 403,000 jobs, or 97 per cent of those lost in the recession. And over the past three months, the number of jobs in the economy has grown by 5.5 per cent – the fastest pace in nearly a quarter-century.

Mr. Guatieri said the recent hiring boom by businesses can’t continue in the rest of the year. "Companies have to focus on efficiency," he said.

(prepared by Barrie McKenna/Globe & Mail)