Risks are lower, Dodge says

With the U.S. economy apparently holding up against downward pressure on the housing and automotive sectors and financial markets showing the resolve to address global imbalances in a smooth manner, the Bank of Canada is predicting inflation will settle at just above 1% for the first half of 2007.

Bank of Canada governor David Dodge made the call during a speech to the Canadian Netherlands Business and Professional Association and the European Union Chamber of Commerce in Toronto. As pressures from house prices ease and the economy remains near potential the bank projects core inflation will stabilize at close to its 2% target in 2008

The main risk to Canada continues to come from our neighbours to the south, where weakness remains in the housing sector,” Dodge said. But he offered some encouraging thoughts. “The slowdown in the U.S. housing and automotive sectors does not appear to have spread more broadly. There is evidence that a significant portion of the adjustment in the automotive sector has already taken place, while the adjustment in the housing sector continues.”

In other words, while the risk remains, it’s been significantly diminished.

Domestically, the main upside risk to the Bank’s economic projection comes from the strong household demand in Canada. “With the increases in house prices in many parts of the country, consumption could be stronger than expected as households borrow against the increased equity in their homes,” Dodge said.

He also noted strong growth in household credit over the past year, but this too is easing.

The last main risk to the Canadian economy that Dodge singled out was the possibility of a less-than-orderly resolution of global current account imbalances, specifically, those gap between the U.S. current account deficit and the surpluses in Asia and the major oil-exporting countries.

Strong U.S. consumption versus the low consumption in places like Asia and OPEC nations has created a “wall of liquidity.”

Still, Dodge remains upbeat. “As long as market participants have reason to believe that policy-makers will take appropriate actions, there is no reason to expect that these imbalances won’t be unwound in a gradual and orderly way.”

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