Growth will force rate hike: Desjardins

Strong rebalancing over the next two years will steer the global economy toward a safer and sounder footing, but concerns linger, according to the latest report from Desjardins Group’s economics department.

The report says many countries — including the U.S. and Canada — have shown improved economic performances recently, although to date this recovery has been modest.

“The financial markets have done well in absorbing the recent debt crisis in some countries and are now focusing on the upcoming interest rate increases,” says François Dupuis, vice-president and chief economist at Desjardins Group.

Canada is leading the charge of the North American recovery buoyed by a strong domestic market.

“Unlike the United States, where the inventory change has played a big role in economic growth at the end of 2009, Canada is benefiting from fairly robust domestic demand,” says Yves St-Maurice, director and deputy chief economist at Desjardins Group.

An improved employment rate is fuelling consumption while public investment plans are benefiting from the current recovery, according to the study. Given the positive trend, economists at Desjardins forecast a GDP growth of 3.0% in 2010 and 2.9% in 2011, trailing not too far behind the global real GDP growth of 3.7% in 2010 and 3.8% in 2011, and ahead of the U.S. GDP growth of 2.7% and 2.4% for the same period.

“Canada’s strong financial institutions, a real estate market that is not too far out of balance, and governments that made the right decisions at the right time are now encouraging the Canadian economy to get back to a more normal situation,” says St-Maurice.

The forerunners of this economic growth, Ontario and British Columbia, are expected to see real GDP increases of 3.3% in 2010. The economic rise of Ontario rides on the back of strengthening real estate and automobile markets. British Columbia, the other torchbearer of the Canadian economic rise, will see its real estate sector staging a strong comeback in the wake of the Olympic Games.

Alberta and Newfoundland and Labrador are expected to post respective GDP growths of 2.8% and 3.0% in 2010, as rising oil prices fuel renewed investment in the energy industry. A tight fiscal and budgetary policy from the government is expected to stymie consumption and the real estate market in Quebec, restricting its GDP contribution to 2.4% in 2010 and 2.6% in 2011. The trend is expected to reverse in 2011 when all Canadian provinces will record stronger GDP growth than British Columbia and Ontario, the study indicates.

Improving economic conditions and corporate profits will help the stock markets maintain their momentum in 2011, predict economists at Desjardins Group. “The S&P 500 should post growth of 13.4% in 2010 and 7.9% in 2011. The S&P/TSX Index’s growth will be slightly slower, at 11.5% and 9.4%, respectively,” report notes.

Strong domestic demand will force an interest rate hike by the Bank of Canada, a step necessary to ensure inflation targets are met. However, currency volatility and its impact on foreign trade could become a concern for the Bank of Canada and will prompt it to rethink the sequence of expected key interest rate increases, according to St-Maurice.

Desjardins Group’s currency forecast also predicts the spread of “Dutch disease” — the negative impact of rapid currency appreciation on a country’s manufacturing sector.

(03/22/10)