Sunday, October 12, 2008

no recession Downside risks present but domestic demand strong enough to keep

Downside risks present but domestic demand strong enough to keep

economy out of recession

The weak U.S. economy and financial market uncertainty will likely result in Canada's economy growing more slowly than in our previous forecast, but has also gone some distance to alleviating concerns about the upside risks to the inflation outlook.

Canada's two-speed economy is likely to persist, with the trade side restraining the overall pace of growth, while the domestic side stays firm and keeps the economy off a recessionary path. Continued support from the improvement in the terms of trade and rising real incomes will underpin household and business demand and will offset some of the impact of the more challenging credit environment.

To-date, borrowing costs for households and businesses have remained well-contained compared to many other countries and the reported tightening in credit conditions has been limited. Still, uncertainty about the global economy and a slowing housing market will likely curb spending going forward.

On balance, Canada's economy is likely to grow at a mild 1% on average in the final quarter of 2008 and early 2009, a favourable result compared to declining growth in the United States, but still well below the economy's potential pace. The downward revision to our economic forecasts and the Bank of Canada's rate cut mean that interest rates are likely to remain lower for longer than we expected when we published

Financial Markets Monthly
in early September. We now expect the overnight rate to finish 2008 at 2.50% rather than 3.00% and for the two-year bond yield to trade around 2.40%.

Ten-year rates are forecast at 3.60% at year-end, lower than our previous projection of 4%.

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A. Mark Argentino
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