Outlook darkens ahead of bank-rate decision

The clouds over the Canadian economy are getting darker, putting pressure on Bank of Canada Governor Mark Carney to make it cheaper to borrow money and threatening Finance Minister Jim Flaherty's promise to balance the budget.

Yesterday's pall was cast by a report showing Canada's economy limped into 2008 at the slowest rate of growth in 4½ years and a declaration by billionaire investor Warren Buffett that the U.S. economy - the biggest consumer of Canada's exports - is in a recession.

"It's hard to look at these numbers and not be quite depressed for 2008," said Don Drummond, chief economist at Toronto-Dominion Bank.

In Brussels, European finance ministers fretted about the toll the record surge in the euro is taking on their countries, another signal there will be no quick rebound in the global demand for the stuff produced by Canada's factories.

Exports decreased a "significant" 2.2 per cent over the final three months of 2007, the first drop in 1½ years, Statistics Canada reported.

Canada's gross domestic product actually contracted in December, the first time that had happened in a month since September of 2006. The 0.7-per-cent drop in economic output in December - led by a 27-per-cent plunge in auto making - was the biggest one-month decrease since the power blackout in August of 2003 cut Canadian production by 1 per cent.

Bay Street economists were unanimous in predicting that Mr. Carney will cut the central bank's benchmark lending rate from the current 4 per cent at the latest interest-rate announcement today at 9 a.m. (ET).

The only question was how deep the cut would be. David Dodge, who stepped down as head of the central bank at the end of January, preferred cautious, quarter-point cuts. That's because the Bank of Canada is mandated to keep a lid on inflation, and cheaper money fuels spending.

After reading the latest GDP figures, some economists said Mr. Carney had little choice but to opt for a bolder, half-point reduction.

"It looks like the first quarter will be closer to zero [growth] than we thought," said Avery Shenfeld, a senior economist at CIBC World Markets in Toronto.

That would make Mr. Flaherty's pledge last week to balance the budget trickier. Like the central bank, the Finance Department was counting on growth of 1.5 per cent in the fourth quarter. The weaker result means Canada's economy was smaller at the start of 2008 than Finance officials anticipated, risking the government's revenue projections.

David Gamble, a spokesman for the Finance Department, said the government remains confident it will raise enough money this year to record a surplus.

Canada won't be getting a lift any time soon from the U.S. economy.

Quite the opposite.

The greenback hit its lowest level since the early 1970s yesterday amid fresh fears the United States is headed for recession. Also putting downward pressure on the U.S. dollar is the surging price of oil, which hit a record high yesterday of $103.76 (U.S.) a barrel - even after factoring in the impact of inflation. That's equivalent to the previous high of $38 a barrel in 1980.

The dollar index, which measures the U.S. currency against a trade-weighted basket of six major currencies, briefly touched its lowest level since the index was created in 1973. The greenback, resuming its sharp descent of last week, also reached a three-year low against Japan's yen and a record low against the euro ($1.5274).

"From a common-sense standpoint right now, we're in a recession," Mr. Buffett, chairman of Berkshire Hathaway Inc., an insurance-to-manufacturing conglomerate, told CNBC Television. His comments coincided with two new reports showing that key pillars of the economy - manufacturing and construction - are in retreat.

The Institute for Supply Management's closely watched manufacturing index slipped below 50 last month, indicating that factory activity is shrinking. The ISM index fell to 48.3 from 50.7 in January. With the exception of exports, which are enjoying the benefits of a falling U.S. dollar, all key components of the index shrank in February.

Meanwhile, the U.S. housing slump shows no sign of easing. Spending on construction projects fell 1.7 per cent in January, dragged down by declining investment in home construction, the Commerce Department reported yesterday.

"The U.S. economy is losing all of its growth engines," said National Bank Financial economist Stéfane Marion. "With consumption, construction, and manufacturing all in the doldrums, the U.S. economy will have a hard time avoiding a contraction in the first quarter."

(prepared by KEVIN CARMICHAEL AND BARRIE MCKENNA/Globe and Mail)