Canadian economy still rolling

The Bank of Canada yesterday added its voice to the growing chorus of experts suggesting the U.S. and Canadian economies may already be exiting the soft patch that bogged them down in the second half of last year.

The bank held its key interest rate steady at 4.25% yesterday and gave no indication it was leaning toward rate cuts, as many analysts forecast for the spring -- this despite the bank acknowledging growth slowed in the second half of 2006.

"There are signs that a significant amount of the adjustment in the U.S. housing and automotive sectors has already taken place and that the inventory correction in Canada is well advanced," the bank said, adding the global economic expansion remains "robust."

The bank's statement joined a glowing appraisal of the global economy yesterday from Rodrigo Rato, managing director of the International Monetary Fund.

Mr. Rato said growth would approach 5% this year, extending a string of four years of strong global growth. A soft U.S. landing seemed "more assured" and the risks to the global economy had diminished, he said.

"This represents very significant expansion of the global economy and probably the longest ? sustained period of growth in the post-Bretton Woods era [of fixed exchange rates after the Second World War]," Mr. Rato said at a news conference in Washington.

He added spillovers to other economies from slower U.S. growth had been minimal, with the recovery broadening in Europe and growth in Japan on track.

Although the Bank of Canada cut its growth outlook for the second half of last year to 1.6%, from 2.4% in October, it maintained its forecast for a pickup to 2.5% in the first half of 2007.

Despite the deceleration in growth, it said the economy was operating at or "just above" its production capacity at the end of 2006.

Nevertheless, core inflation was expected to return to its 2% target in the first half of 2007 from 2.2% now, instead of the second half of the year as forecast in October.

"Overall, I think the market has taken it a little more hawkish than expected," said Camilla Sutton, currency strategist at Scotia Capital. "It potentially does push out the potential for a rate cut for a little further in 2007."

Many analysts had been expecting the bank to start cutting interest rates in April as damage from the U.S. housing market retreat started to drag down U.S. consumer spending, knocking Canadian growth.

But the bank may have been heartened by data showing U.S. housing beginning to stabilize and the rest of the U.S. economy bubbling along, bolstered by solid business investment and job growth.

U.S. Federal Reserve officials have been banging this drum in recent speeches.

"If you take out housing and ... if you take out autos right now, too, the rest of the economy seems to be running pretty much at full capacity," Fed Governor Susan Bies said last week.

For the first time in months, U.S. futures markets are no longer pricing in a rate cut right up until the end of September.

Canadian data have also recently turned more positive after a soggy patch in the fall.

Notably, the bank seems more comfortable about its outlook. It said in its statement the main upside and downside risks "diminished somewhat" from its October outlook.

In October, the main upside risk was stronger consumer spending and house prices, while the main downside risk was a sharper U.S. slowdown.

Mark Chandler, fixed-income strategist at Royal Bank Capital Markets, said trade would likely drag less on the Canadian economy with the slightly weaker loonie, while stronger government spending, non-residential construction and business investment will also boost growth.

"We have one rate cut but it's very much data-dependent," he said. "There's going to be a small window where growth still looks somewhat sketchy from the carryover from '06 and inflation starts to come off. If the Fed [cuts], then the [Bank of Canada] can have a fine-tuning cut," he said.

But Ms. Sutton still contends the Bank of Canada will end up cutting rates.

"I think there's still a little more to come in terms of the U.S.," she said. "I think we'll wait to see a few more data points from housing and to make sure employment is as strong as it seems

(prepared by Jacqueline Thorpe/Financial Post)