Canada: Patches of Sun in a Cooling Trend

The Bank of Canada finally capitulated to the obvious. It revised lower its forecast for Canadian growth, citing the slowdown in the U.S. economy.

The BOC's Monetary Policy Report projects that real gross domestic product will grow 2% in 2001. That's down from a forecast of 3% in February and a strong 4% in November, 2000. Growth is expected to be weaker in the first half of 2001, then pick up in the second half. In 2002, real GDP should rise 3%. Soft growth has also been signaled by the index of leading indicators, which has fallen for four straight months (chart).

The policy report said the main risk to the Canadian economy was that "the U.S. slowdown could be more protracted than anticipated." That would cut export demand from the U.S., Canada's main trading partner.

There are some bright spots, however, in the Canadian outlook. Domestic demand, especially from consumers, remains strong, thanks to tighter labor markets. Despite an unexpected drop in March housing permits, homebuilding is expected to rise 4.6% this year, according to the Canada Mortgage & Housing Corp. And oil and gas producers are getting a lift from growing energy demand from the U.S. Meanwhile, manufacturers were less pessimistic in April than they were in January: Fewer expect to cut production in the second quarter than in the first.

Growth should also get a lift from the renewed weakening in the Canadian dollar. It has fallen some 2% since the start of the year. The slide will make Canadian goods more competitive around the world. And it should boost tourism as cash-strapped Americans look for cheaper summer-vacation destinations.

Even so, the BOC's slower outlook ensures that policymakers are not done cutting interest rates. Short-term rates have already fallen by a full percentage point this year. But low inflation, at 2.5% in March, and rate-cutting in the U.S. mean that the BOC has plenty of room to inject some more stimulus into the economy.

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