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Global Economic Uncertainty Will Keep Canada's Growth Moderate in 2012: RBC Economics

  • Central banks expected to keep interest rates low and maintain liquidity
  • Canada's net debt to GDP ratio the lowest among the G-7
  • Scope of European economic crisis widens - Europe expected to slip into recession

TORONTO, December 6, 2011— After a turbulent year, Canada's economy is set to grow by 2.5 per cent in 2012, according to the latest economic outlook issued today by RBC Economics. Commodity prices remain at historically high levels, the U.S. is projected to continue to grow and the Bank of Canada is keeping monetary policy accommodative, all of which will support growth in Canada. However, the forecast includes the key assumption that European policymakers contain the sovereign debt crisis in that region.

"Canada's economy experienced some large swings in growth in 2011. The second quarter's unexpected contraction was a response to a number of temporary factors - the natural disasters in Japan, reduced auto industry activity and wildfires in Alberta. As these factors reversed, a strong rebound followed in the third quarter," said Craig Wright, senior vice-president and chief economist, RBC. "While the initial release of second quarter data prompted some talk of a double-dip recession, third quarter data proved otherwise."

The Bank of Canada has held interest rates at low levels in the face of heightened uncertainty about the global economy, moderate growth in Canada and expectations that inflation will remain steady. Recently, the Bank of Canada reaffirmed its two per cent inflation target for the next five years and signalled its continued commitment to flexible policy making.

"The Bank of Canada's flexible stance during the financial market crisis helped to ensure Canada's economy navigated through the worst of the downturn," said Wright. "Given concerns about the weakening global economy and its impact on Canada's growth momentum, we expect that the Bank of Canada will maintain its accommodative policy at least until mid-2012."

The RBC report notes that, as governments tried to fend off a deeper recession, Canada's fiscal deficit ballooned, causing an increase in the net debt-to-GDP ratio, though this ratio remains the lowest among G-7 nations.

Canadian consumers provided the biggest boost to growth in 2010 and in 2011, businesses also kicked in. Spending on machinery and equipment along with non-residential real estate accounted for almost 60 per cent of the annual growth rate.

The biggest change to the composition of growth will come from net exports, driven by stronger U.S. expansion and rising demand for auto and energy products. U.S. real GDP is forecasted to expand by 2.5 per cent in 2012.

Canadian imports are also forecasted to increase, however the pace is expected to moderate from the 10 per cent average experienced over the last two years. The strong Canadian dollar created an incentive to buy productivity-improving capital goods, as it cut the cost of imported U.S. machinery and equipment for Canadian companies.

During the early days of recovery, rapid increases in Canada's consumer debt recently pushed household debt-to-income over that in the U.S. To date, this debt accumulation has not slowed enough to cause a turnaround in the debt-to-income ratio. The debt-to-asset ratio is set to rise, as the gains in real estate values were more than offset by falling financial assets in the third quarter.

"The debt situation has made the economy more vulnerable to a sharper downturn should there be any unexpected shock like a deterioration in the labour market, a drop in housing prices or spike in interest rates," explained Wright. "In the near term, we do not see a catalyst for any of these risks to come to fruition. A backdrop of low interest rates and a stable labour market will allow households to manage their debt loads."

The ongoing European sovereign debt saga is hurting the growth outlook for the region and weighing on exports of the European Union's key trading partners. These direct effects on the global outlook are made even more powerful by the indirect hit coming from volatile financial markets. The risk that businesses and households refrain from spending until there is clarity on how the European situation will play out is amplifying the risk that some countries will slip back into recession.

Although structural challenges will remain, there appears to be progress on resolving the sovereign debt issues, meaning that the expected Euro-area recession is likely to be short-lived, with no growth in 2012 followed by positive but weak growth in 2013, subdued inflation, and European Central Bank monetary policy staying exceptionally accommodative.

A complete copy of the RBC Economic and Financial Market Outlook is available as of 8 a.m. ET today.

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For more information, please contact:

Craig Wright, RBC Economics, 416 974-7457
Paul Ferley, RBC Economics, 416 974-7457
Elyse Lalonde, RBC Economics, 416 974-7457

 

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