TORONTO, June 17 /CNW/ - Canada's economy has proven to be resilient in the first half of 2010 but potholes remain along the road to economic recovery according to the latest economic forecast from TD Economics. (www.td.com/economics)

Canada's recovery has been "defying the odds"

Canada has been defying the odds in the early stages of recovery. For the third consecutive quarter, the combined spending of consumers, governments and businesses in the first quarter of 2010 powered ahead by a 5% annualized rate -- about four times the rate recorded by the G-7 as a whole. Preliminary data in Q2 points to an expansion of at least 4%.

"The pace of Canada's economic revival stands out in the world. Real GDP has virtually recouped all of the losses recorded during the recession. And real consumer spending has already eclipsed its pre-recession level," said Craig Alexander, Chief Economist for TD Bank Financial Group.

The job market has also recouped about three-quarters of the losses suffered during the recession. It is set to grow at an annualized rate of 3.6% in the second quarter, marking its strongest gain in eight years.

There was more good news. Housing starts data have been pointing to continued strength in residential investment despite the expiry of the federal renovations tax credit in February. And a preliminary tracking of U.S. real GDP growth points to another healthy expansion in export volumes in the April-June period. Even machinery and equipment (M&E) spending, which had been among the few domestic weak spots, appears to have turned the corner in the first quarter, posting a healthy gain.

Bumps ahead

But going forward the economy is expected to face more bumps. "Canada - as a small, open resource-based economy - is heavily influenced by global developments," said Mr. Alexander.

For instance, Europe's debt crisis underscores the challenges of the financial crisis have yet to be resolved. However it will most likely dent but not derail the global economic expansion. Elsewhere, the impacts are likely to be relatively modest on the whole, provided that renewed fears of contagion don't resurface.

Still, a heightened level of risk aversion, a stronger U.S. dollar and ongoing concerns about world growth are likely to pose a barrier for commodity prices, which could negatively impact Canada's economic performance. For instance the projected range for crude oil prices has been adjusted to US$65-80 per barrel over the next year, down from US$75-85. Natural gas prices are expected to remain relatively depressed this year. And base metal prices are unlikely to see much upside over the next few quarters.

The Canadian dollar is now projected to average close to 95 cents -- posing less of a drag on the economy, but remaining at a challenging level for exporters.

Momentum fades away

The domestic sectors of the economy will likely see momentum fade significantly in the second half of 2010 and into 2011. Consumers, in particular, have been growing their spending more quickly than income and amassing debt. By the first quarter, household debt reached 1.5 times personal disposable income (PDI), on average. At the same time, the personal savings rate was only about 2% in the January-March period.

Prospects for respectable job growth will help to soften the adjustment to a lower spending track. A moderate 20,000-25,000 net new jobs per month are projected to be recorded through the end of 2011, sufficient to power solid annualized PDI growth of 4-5%.

Growing consumer fatigue is also impacting the housing market. Home sales have declined in each of the last four months, and are expected to continue to trend down in the remainder of 2010 and in 2011. This will lead to a 7% drop in average prices from their peak in the second quarter of 2010 to the end of next year.

Governments will likely begin to tap on the fiscal brakes in order to rein in large deficits as well. Not only will this mean the end of infrastructure and other temporary stimulus programs but also the gradual restraining of operating spending, as laid out in 2010 budgets. As a result, a modest overall decline in real government spending is expected in 2011.

Bottom line

Despite the scaling back of growth prospects next year, TD Economics' outlook for growth and inflation is consistent with a steady but gradual increase in Canadian short term interest rates in the second half of 2010 and in 2011, to a level of 3.00%. Given the more moderate pace of economic expansion ahead, economic slack will be taken up slowly taken, with the economy expected to return to estimated potential output at the end of next year. Perhaps most importantly, core inflation - which has proven surprisingly resilient - is expected to hold in a relatively narrow band just under the Bank's 2% target.

On a regional basis, the pendulum of growth is expected to shift from central and eastern provinces - which, along with B.C., have led the charge in recent quarters - to the Prairies.

"The recent strength of Canada's economy has helped to reinforce the view that Canada's recovery is for real. Still, bumps lay ahead as households and governments shift their attention to addressing their recent largesse," said Mr. Alexander. "What's more, volatility remains the watchword of the day. There are risks of renewed bouts of financial market volatility stemming from worries over sovereign debt that will continue to muddy the picture. There is uncertainty over the fragility of the strength of the economic recoveries in much of the industrialized world, and some concerns about whether the strong recoveries in emerging markets could create significant imbalances. These risks warrant close monitoring, but the most likely scenario remains for moderate Canadian economic growth ahead."