Canada: The Great White North Gets the Cold Shoulder

The U.S.-Iraqi war, though swift, threatens one of the world's most secure and sizable economic bonds: the relationship between the U.S. and Canada.

The financial fallout of Canada's decision not to join the coalition became clear when the U.S. Ambassador to Canada, Paul Celluci, warned of "short-term strains" between the two countries. Already, the Aerospace Industries Association of Canada said U.S. customers have withdrawn or delayed work to be done in Canada. And Safety Boss Inc., the Calgary oilfield service company, was effectively cut out of any Iraqi oil-well rebuilding when the contract was awarded to U.S. rival Halliburton Inc. (HAL ) In the latest blow, President George W. Bush canceled a May trip to Ottawa.

For now, Canada's economy is well positioned to withstand the dispute. Thanks to low real interest rates and strong domestic demand, the economy will probably grow just shy of 3% in 2003, after a 3.4% advance in 2002. That means Canada should grow the fastest of any of the Group of Seven economies.

This rapid growth has fueled a runup in inflation, however. In February, consumer prices were up 4.6% from a year ago, the biggest jump in 12 years. In response, the Bank of Canada has gone into tightening mode. On Apr. 15, it hiked the overnight lending rate by a quarter-point to 3.25%, the second increase in just two months. The BOC said firm demand and job growth mean "economic activity in Canada remains near full production capacity," leaving the door open for more rate hikes later on.

But since Canada sends more than 80% of its exports to the U.S., any long-run bilateral strain will cut into growth. Plus, the economy is at risk from the severe acute respiratory syndrome virus. Already, 13 people have died in the Toronto area. Tourism has suffered, which will be a drag in the second quarter and perhaps beyond depending on how the SARS epidemic plays out. To offset the reduction in tourism, and to keep exports growing, Canada's politicians will need to resolve the squabble with the U.S. quickly.

By James C. Cooper & Kathleen Madigan

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