Economists expect more of the same in 2006

With the S&P/TSX Composite Index coming off a 22% gain in 2005, the loonie soaring and the demand for our commodities near record highs, it’s easy to think Canada’s economy is firing on all cylinders. Bank economists speaking on Wednesday at the Economic Club of Toronto agreed Canada’s financial picture looks good overall, but warn of underlying problems.

Most Canadians would concur that the economy is strong, but at the individual level most feel as though they are falling behind the cost of living, according to a poll presented by Pollara and released at the breakfast meeting.

The poll also found that attitudes towards the strengthening Canadian dollar have changed. Once viewed as an anchor on our unproductive economy, it is now seen as being generally positive. (For more on this survey, please click here).

Looking ahead, economists seem to share this opinion as they cautiously dismiss negative trends as being less of a concern today than in previous years. By and large, they expect 2006 will be much the same as 2005.

“If you look at the broad aggregate numbers it reminds me of the story where you have your head in the oven and your feet in the ice and on average you feel just fine,” says Avery Shenfeld, senior economist at CIBC World Markets.

The energy producing provinces, particularly Alberta, will do quite well, Shenfeld believes. Canada’s manufacturing heartland won’t be so lucky. With auto sales starting to give way he expects Ontario and Quebec will slow to about 2% growth.

Warren Jestin, chief economist at Scotiabank, expects an even more dramatic difference between the provinces as growth in Ontario and Quebec slows to between 1% and 2%.

This sort of regional split will be evident to the south as well. The U.S. housing market is perhaps the best example. There is evidence of the market slowing down, but these cases are isolated and, at the risk of saying it’s different this time, BMO Financial Group’s chief economist, Rick Egelton, says doesn’t expect to see the housing market burst like it did in the ’80s.

Shenfeld agrees. Even though the U.S. economy is showing cracks, with consumer spending slowing and people taking on higher mortgages, it’s not headed towards a recession.

The recent inversion of the bond yields, where the two-year yield is at or higher than the 10-year yield, indicates bond traders are worried that energy prices will continue to rise and put pressure on the market in the near term. Generally, that signals the onset of a recession within the next four quarters.

But neither Shenfeld nor Egelton see this as the case this time around. Egelton sees energy prices easing though the year, while the U.S. economy will benefit from fiscal stimulus as the states along the U.S. Gulf Coast rebuild after Hurricane Katrina. Shenfeld believes the Fed could start to roll back interest rates in 2007.

Overall, Egelton believe the U.S. economy will perform well and the Fed will be able to continue to tighten its monetary policy. “There is an expectation in the bond market that the Fed will have to reverse course,” he says, but “we don’t think a reversal in course is likely and that will become apparent to the bond market as the year progresses.”

The direst prediction for 2006 comes from Don Drummond, chief economist at TD Bank Financial Group. He expects the Bank of Canada will raise rates to 4.75% and then hold for the rest of the year. At the same time he sees consumer debt halting growth in consumer spending and a slowdown in our exports.

As for the loonie, economists expect it will continue its flight in 2006. But rather than pin a specific target as they have in previous years, most say the Canadian dollar will continue to push toward 90 cents US.

Filed by Mark Brown, Advisor.ca, mark.brown@advisor.rogers.com

(01/04/06)