Economy seen climbing in 2005, despite higher interest rates

(October 6, 2004) Rising household net worth and a strong labour market should boost the Canadian economy next year, says RBC Financial in its latest forecast, despite higher interest rates. RBC expects 3.1% economic growth this year, climbing to 3.6% in 2005.

Canadian households have responded to a low interest rate environment by driving up debt and boosting assets. Although this means personal savings rates are declining, RBC economist Craig Wright says increasing debt levels to purchase assets, such as new homes, is a “rational” move, considering that borrowing costs haven’t been this low in decades. In the 12 months ending in June, 2004, household net worth rose by an inflation-adjusted 4.4%, he notes.

“Household debt levels have been growing quickly but have yet to put a dent into spending because assets have been rising faster and the debt-service burden has been falling,” Wright explains.

Recent moves by the central bank to boost interest rates, a trend RBC expects to continue next year, with the overnight lending rate predicted to reach 4% by the end of 2005, likely won’t be a problem for households, since the labour market is generating wage gains. In the first half of 2004, real disposable income rose at an average annual pace of 4.5%, boosted by a rise in hourly wage rates.

Businesses are also expected to perform well in 2005. Although RBC says 2004’s “torrid” pace of 20% growth will slow next year, it should still remain in the double digits in 2005.

Inflation is also expected to remain under control in the near future, thanks to a number of factors, including the continuing strength of the Canadian dollar, which RBC says could hit 80 cents US by year’s end.

Filed by Doug Watt, Advisor.ca, doug.watt@advisor.rogers.com