4. What is your economic outlook for North America in
2006?
Growth rate disparities between Canada, the U.S. and
other G7 economies are in the process of narrowing. Just
as Canadian real GDP growth is accelerating, the U.S.
economy is set to slow moderately. We expect real
Canadian GDP growth to pick up from 2.9 per cent in 2005
to 3.4 per cent in 2006 and U.S. real GDP growth to slow
from 3.4 per cent in 2005 to 3.2 per cent in 2006. Lower
inflation, a more accommodative monetary policy, and
sharply higher energy and non-energy commodity prices
are behind the expected improvement in Canadian growth.
The U.S. economy is expected to slow down because
consumers and businesses are expected to begin saving
more in response to higher interest rates.
Lower U.S. investment and consumption growth should lead
to less borrowing of foreign funds. As a result more
funds are expected to remain in lending countries
promoting local investment and consumption. We expect
improving Canadian growth in 2006 to result in continued
rate hikes and the Bank of Canada overnight rate of
interest is expected to reach 4 per cent by April 2006.
The U.S. federal funds rate has already been rising for
over a year and is expected to peak at 4.25 per cent in
the last quarter of 2005 and remain at that level in
2006. The rising cost of raw material inputs along with
rising wages pushed the U.S. Federal Reserve to act
earlier than the Bank of Canada in hiking rates.
Longer-term interest rates are also expected to rise in
both countries alongside slowly mounting core consumer
price index inflation pressures, leading mortgage rates
to rise. The hot Canadian and U.S. housing markets are
expected to soften as demand shifts lower with higher
borrowing costs. Unlike prior real estate cycles,
however, an implosion of the real estate market in
either country is unlikely since construction has only
kept pace with demand as speculative construction frenzy
in both countries was avoided.
Given our outlook, several offsetting factors should
keep the value of the U.S. dollar trading in a narrow
range.
Firstly, less borrowing of foreign funds by the U.S. is
expected to limit further weakening of the U.S. dollar.
At the same time, however, the U.S. dollar could come
under downward pressure with expectations of continued
interest rate hikes in Canada and other G7 countries
offsetting hikes in U.S. shortterm interest rates.
Furthermore, the Canada-U.S. exchange rate will also be
affected by weaker commodity prices. The Canadian dollar
is, therefore, expected to fluctuate in a range of 82 to
85 U.S. cents. Other currencies are also expected to
stabilize relative to the U.S. dollar in 2006 giving
exporters in these countries a reprieve as they continue
to adjust to intense pressure from Chinese exports.
The risks surrounding our North American economic
outlook are unusually widespread. The war in Iraq and
the threat of civil war if the U.S. pulls out early,
increasing friction between China and Japan, not to
mention the nuclear proliferation threat coming from
North Korea could all lead to another bout of higher oil
prices, lower demand, lower interest rates, rising
inflation and perhaps a period of stagflation. For now,
however, our base case consists of a converging business
cycle between G7 economies, particularly between Canada
and the U.S.
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