U.S. set to beat Canada’s GDP growth: TD’s Drummond

(June 27, 2003) The Canadian economy has had a good run, but its luck is running out, says Don Drummond, senior vice-president and chief economist at TD Bank Financial Group. He predicts that very soon the U.S. economy will begin to outperform Canada’s.

“Canada’s economic outlook has soured noticeably in recent months,” Drummond said in a research note released on Friday. “As a result, for the first time since 1998, the U.S. economy is poised to outpace Canada’s, and will do so both this year and next.”

He pointed out the recent scares over severe acute respiratory syndrome (SARS) and mad cow disease have had an impact on the economy, but that the real problem remains the value of the Canadian dollar.

“The Canadian dollar has finally taken flight, but the currency has gone twice as far and twice as fast than even the most optimistic of forecasters had predicted,” Drummond said.

R elated Stories

Manley continues promotional tour Manley: Canada remains a “northern tiger” despite challenges

The dollar soared an incredible 18% in early 2003 and remains near these highs as the year drags on. Such high valuations hurt Canadian exporters not only by raising the relative price of their products, but also by reducing the value of transactions in U.S. dollars.

There is plenty of evidence to support Drummond’s prediction of a slowing economy.

Federal Finance Minister John Manley has been on the road this week, telling audiences in Toronto and New York that, while he remained confident Canada’s economy was solid, predicted GDP growth was being revised downward by 1%, to around 2.2%. That, he pointed out, was still enough to lead the G-7.

Then on Friday, StatsCan released the April GDP report, showing that the economy had contracted for the first time since September 11, 2001, falling by 0.2%. Leading the decline were raw materials and energy, largely due to decreased heating demand.

But even the housing market, which had been the strongest point in the economy, started to show some weakness. And manufacturing, perhaps the most important sector of the economy, slowed as well, partly due to the reliance on exports to the U.S.

Drummond is not the first big-bank economist to warn that America is set to outperform. On June 13, Sherry Cooper, global economic strategist and executive vice-president of BMO Financial Group, said that the combination of tax cuts and extremely low interest rates should boost the U.S. economy for 2004, which, she notes, is an election year.

Partly to blame for the dollar’s value is the growing gap between Canadian and U.S. interest rates. While Bank of Canada overnight rate target is currently 3.25%, the U.S. Federal Reserve has cut its overnight rate to just 1%. This spread has many economists calling for a cut to make the loonie less attractive.

Drummond predicts the Bank of Canada will likely follow suit and cut rates by 25 basis points in each of the next two rate adjustments.

Corporate spending

Cooper predicted that the real driver of U.S. growth will be corporate capital spending. “For the first time since the Second World War, businesses are using up productive capital faster than they are replacing it, creating pent-up demand for new business equipment,” she said in the June 13 report on www.sherrycooper.com.

Cooper said this increased activity will likely help to mitigate any real downturn north of the border.

Not necessarily so, said Drummond.

“The bulk of the impact of the Canadian dollar’s appreciation on the Canadian economy has yet to be felt,” he said. If Canadian export prices continue to be undercut by the cheap U.S. dollar, capital expenditures may be focused on American products.

He believes that a third- or even fourth-quarter recovery is doubtful and that early 2004 is a more likely timeframe for U.S. growth.

“Although business confidence has improved, and balance sheet repair is underway, the lack of growth in corporate profits remains an obstacle to a more vigorous pickup in business spending,” he said in the report.

And past that, he sees the next major problem facing the U.S. to be the ever-expanding deficit, exacerbated by the very tax cuts aimed at curing the economy.

---

Do you think it’s clear sailing for the Canadian economy, or are we headed for the same storm as the U.S.? 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

(06/27/03)

Steven Lamb