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Special Reports


RBC says financial market turmoil to dampen Canada's economic growth

Domestic economy remains firm as historically high commodity prices continue to buoy income

TORONTO, October 8, 2008 — The persistent turmoil in financial markets and disappointing economic trends over the past two quarters have prompted RBC to revise downward its growth outlook for Canada to 0.9 per cent from 1.4 per cent. RBC Economics expects Canadian economic growth to rebound slightly in 2009, to a moderate 1.5 per cent.

"The continued weakness in the U.S. economy is expected to dampen growth in Canada," said Craig Wright, senior vice-president and chief economist, RBC. "However, this pressure on our growth will be tempered by strong commodity prices which are contributing to robust export revenues and providing support to Canadian domestic spending via a boost to incomes."

The report highlights that one of the key strengths in Canada's domestic economy has been the significant rise in gross domestic income (GDI) that accompanied the strong rise in commodity prices over the past year. Canada's GDI has outstripped its GDP growth, resulting in strong increases in consumer spending, business investment and import demand. Despite the recent weakening in commodity prices, Canada continues to enjoy the benefits from a positive term of trade shock.

Canada's housing market is showing signs of coming off the boil after almost a decade of growth, the report notes. However, any weakening is expected to be more moderate compared to the U.S. experience as Canadian mortgage markets did not see the excesses that afflicted the U.S. housing sector.

Fatigue also appears to have set in with Canada's labour market. After generating 320,000 new positions on average each year from 2002 to 2007, the pace of job gains has slowed to just 87,000 for the first eight months of 2008.

Earlier this year, the Bank of Canada had been highlighting the risks of both an inflation rate above its target band and an economy barely growing. However, the re-emergence of tighter credit conditions has pushed the downside risks of growth to the forefront, and with the U.S. falling into a recession, RBC expects that the Bank of Canada will lower the overnight rate a further 50-basis points before the end of the year.

South of the border, the U.S. economy grew at a stronger-than-expected 1.9 per cent average pace in the first six months of 2008, supported by the government's tax rebate package. This performance was contrary to projections made earlier in the year that the U.S. economy would post no growth or contract slightly in the second quarter. However, looking into 2009, RBC has downgraded its forecast for U.S. economic growth to a recessionary 0.2 per cent as the ongoing credit tightening takes a further toll on the economy south of the border.

"This weakening in the U.S. economy is being exacerbated by high gasoline prices, a softening labour market and an erosion in Americans' net worth," said Wright. "This is being overlaid on top of the unwinding of the fiscal stimulus package effect which will dampen consumer spending activity."

The RBC report expects a cumulative 100-basis points in reductions in Fed Funds before the end of the year. "The Fed faces a complicated landscape as policymakers try to deal with the crisis in the financial services industry, weakening economic outlook and rising inflation rate. For now the most likely course is that policymakers will continue to supply liquidity to financial markets while closely monitoring the risks to the economy and inflation outlook," Wright noted.

The general outlook for all provinces has generally darkened as a result of the recent dramatic turn in the year-long financial market crisis. The U.S. economy now appears to be in recession with Europe, the U.K. and Japan also sinking fast. While Canada is in better position with its financial sector less heavily impaired, overall growth will be substantially weaker than previously anticipated.

Among the provinces, Saskatchewan will lead the way this year and next in terms of economic growth, with Manitoba closely behind. The Atlantic region is expected to display continued resilience and should sustain a moderate pace of expansion for the most part. Conditions in the most western part of the country are on a deteriorating path. Eroding housing situations and rapidly slowing growth in consumer spending have prompted downward revisions to the forecasts for British Columbia and Alberta. With weak external trade continuing to exert a toll, cracks have appeared in the domestic foundations of Ontario and Quebec with Ontario likely to experience little to no growth this year and next.

The RBC Economics Provincial Outlook assesses the provinces according to economic growth, employment growth, unemployment rates, personal income growth, retail sales, housing starts, and the Consumer Price Index.

A complete copy of the forecast is available as of 8 a.m. E.D.T., at www.rbc.com/economics/market/pdf/fcst.pdf.

- 30 -

For more information, please contact:
Craig Wright, RBC, Economics, 416-974-7457
Jackie Braden, RBC, Media Relations, 416-974-2124


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10/08/2008 10:45:57