TORONTO, Dec. 15 /CNW/ - Economic growth prospects for Canada in 2011 have brightened since the September TD Quarterly Economic Forecast, with the economy now projected to expand by 2.6%, up from 2.0% in the prior forecast.  Despite the upward revision, flat housing markets, high indebtedness, subdued income gains, and waning fiscal stimulus are expected to remain key headwinds keeping economic growth moderate (www.td.com/economics).

Stronger U.S. growth will boost Canadian exports

The release of data for the third quarter pointed to a second consecutive deceleration in real GDP growth - to only 1% at annual rates.  While this performance was disappointing, it is likely to represent the low-water mark, with economic growth set to reaccelerate over the next few quarters.  For 2011 as a whole, TD Economics is projecting an annual average expansion of 2.6%, about one half of a percentage point higher than predicted in the early autumn.  

"A large part of the near-term upgrade in activity can be chalked up to an improved outlook for resource and non-resource exports" said Craig Alexander, Chief Economist for TD Bank Group. He points to recent moves by U.S. officials to stimulate the world's largest economy by undertaking additional quantitative easing, extending the Bush tax cuts and providing other forms of tax relief.  While these measures will make monetary and fiscal exit strategies more challenging down the road, they will add to growth substantially in the short haul.  TD Economics is expecting U.S. real GDP growth to reach 3% in 2011, up about a full percentage point from the previous forecast.

In addition to stronger U.S. activity, another influence that is likely to be supportive to Canadian exports next year is commodity prices, which are now projected to be sustained at higher levels than expected a few months ago and continue to advance in the coming year.  Further, the Canadian dollar is projected to weaken in the first half of next year before recovering thereafter.

Consumers face constraints in taking advantage of low rates

Another key development over the last three months has been the scaling back of expectations of rising interest rates in Canada.  Not only have some of the benefits of lower U.S. interest rates spilled over the Canada-U.S. border, but TD and other forecasters now expect that the Bank of Canada will leave its overnight rate at 1% until mid-way through 2011. 

"The upside surprise in existing home sales over the past few months indicate that Canadian households are responding to the attractive borrowing conditions," said Alexander. "That said, we believe that high debt levels will prevent consumers from embarking on another spending spree."

Lacklustre labour market conditions are another factor that will keep consumer spending in check.  Alexander argues that the significant boost to real GDP growth in 2011 is unlikely to be matched by a commensurate improvement in job creation. "Canadian companies, particularly those in export-oriented businesses that are exposed to global competition, are likely to focus on satisfying demand through efficiency gains rather than hiring." Continued tepid job creation in the private sector, combined with frugal governments, is expected to keep the unemployment rate elevated at around 7.5% next year.

However, business investment should remain a major pocket of strength, owing in part to government policies that have improved the tax environment in recent years.  In particular, growth in machinery and equipment outlays is projected in double-digit territory next year. 

Economic growth downgraded modestly in 2012

The momentum in exports and investment is expected to continue in 2012, helping to keep the recovery moving forward.  Higher interest rates are expected to put somewhat of a damper on consumer spending, leaving overall real GDP growth at a moderate 2.5% in 2012 - or 0.3 percentage points below TD Economics prediction in September.  Beginning in the second half of 2011, the Bank of Canada is expected to resume tightening of monetary policy, with its overnight rate projected to reach 3% by the end of 2012. 

"Similar to what occurred in 2009, these rate hikes are likely to be anticipated by households and this will result in purchases of homes and other big-ticket items being brought forward to the first half of 2011," says Alexander.  He also notes that that the high indebtedness of households will make them unusually sensitive to rising interest rates.

Prairies and Newfoundland & Labrador to lead the way in 2011-12

The report provides revised provincial economic forecasts. Since mid-year, the growth pendulum has swung away from Central Canada, British Columbia, and parts of the Atlantic, towards the Prairies and Newfoundland & Labrador.  Looking ahead to the next few years, there appears to be little stopping these economic growth leaders from maintaining an above-average turnout of at least 3% per year.  "Over the next few years, the reliance of these provinces on well-performing commodity markets and their relatively strong fiscal positions will put them in good stead."