Banks warn Canada will lose top G-7 spot to U.S.

(July 8, 2003) While the U.S. economy will be slow to recover, it should outperform the rest of the developed world as the global economy stagnates, according to reports released today from Scotiabank and RBC Financial Group.

Despite incredibly low interest rates and tax cuts intended to spur economic activity, the U.S. is on the slow road to recovery, according to Scotia’s Global Outlook.

“The U.S. economy is overbought, overbuilt and overleveraged,” said Warren Jestin, Scotiabank’s chief economist. “These fundamental imbalances will dampen the revival in household and business spending south of the border expected to be generated by additional tax cuts, ultra-low borrowing costs and the sharp U.S. dollar reversal.”

Ironically, these incentives may be part of the problem, as “cheap money” has fueled a spending spree in the U.S. over the past decade. Consumers have already loaded up on big-ticket durable goods, such as automobiles and household appliances, leaving manufacturers saddled with huge inventories of these goods.

With little market for these goods, businesses are unlikely to embark on significant capital expenditures. Since the U.S. is the prime target market for Canadian manufactured goods, the effects will be felt north of the border as well.

But there is an upside to our close ties, as both RBC and Scotiabank predict the U.S. economy will stumble its way to the top of the G-7 for growth. This ends Canada’s five-year streak of outperforming America, but they predict we should remain in near the top.

The Scotiabank report foresees U.S. GDP growth in the neighbourhood of 2.25% for 2003, and just over 3% for 2004. The economists at RBC seem to concur, calling for U.S. growth of 2.2% and 3.4% in the same periods.

Canada is expected to benefit from this U.S. growth, outpacing Europe and Japan, with Scotiabank predicting growth rates of 2% in 2003 and 2.7% in 2004.

While severe acute respiratory syndrome and mad cow disease have taken a toll on the Canadian economy this year, the single biggest hit remains the export-stifling strength of the loonie versus the greenback.

Craig Wright, vice-president and chief economist of RBC Financial Group, says this problem could linger until 2004.

“While foreign exchange markets will remain volatile as the U.S. dollar correction runs its course, the Canadian dollar will retain its rising trend,” Wright said in the RBC report. He predicts the dollar will hit 75.2 U.S. cents by the end of 2003 and climb as high as 77.5 U.S. cents by the end of 2004.

The traditionally low Canadian dollar had been a counterweight to the U.S. edge in productivity. Both RBC’s Wright and Scotiabank’s Jestin see this as reason for the Bank of Canada to alter course.

“The 10 cent (US) rise in the Canadian dollar during the first half of 2003 has effectively neutralized the Bank of Canada’s bias to gradually nudge up domestic interest rates,” says Jestin. “Looking ahead, the bank will likely follow the Fed in easing over the summer, with more to come as the economy lags through the fall.”

The RBC report was a little more cautious, suggesting that while the Bank of Canada has set aside its bias toward raising rates, it was more likely to leave rates unchanged until the second half of 2004.

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Is U.S. economic growth set to eclipse Canada’s? Is the high value of the loonie killing our competitive edge? Share your thoughts or ideas with your peers in the Talvest Town Hall on Advisor.ca.

Filed by Steven Lamb, Advisor.ca slamb@rmpublishing.com

(07/08/03)

Steven Lamb