Expects Canadian Dollar to Weaken. Canada's economic growth is expected to accelerate to 3.3 per cent in 2006, from 2.9 per cent in 2005 before slowing to a 2.9 per cent pace in 2007, according to the latest economic forecast from RBC Financial Group.
"Despite inflation concerns and rising interest rates in North America and elsewhere around the world, tight labour markets, rising wages and a diminishing drag from net exports are helping to sustain growth in both Canada and the U.S. this year," said Craig Wright, vice-president and chief economist, RBC. "We expect Canada's economic growth to outperform the U.S. Due to rising business investment."
U.S. economic growth is expected to slow to 3.3 per cent in 2006 from 3.5 per cent in 2005 before slowing further to 2.7 per cent in 2007. RBC notes that North American consumer spending is expected to slow as the positive wealth effect caused by higher home values winds down alongside the softening North American housing market. The continued cooling of the U.S. housing market will reduce GDP growth more than in Canada because the Canadian housing boom began from lower levels relative to the U.S.
According to the report, Canada and the U.S. are experiencing a revival in non-residential construction that should absorb resources liberated by declines in residential construction. As well, North American business investment in productivity-enhancing technology is expected to improve growth this year and next.
The Bank of Canada raised the overnight rate to 4.25 per cent in late May, the highest level since August 2001, and signalled that monetary policy was now consistent with meeting the central bank's stated medium-term inflation targets. Interest rates in Canada are getting close to their cyclical peaks with limited increases in core inflation expected. RBC forecasts that the Bank of Canada will likely hike the policy rate once more to 4.5 per cent and leave it at that level for the remainder of 2006.
"With Canadian interest rates increasing more slowly than U.S. Rates, some of the momentum in the Canadian dollar will be removed," said Wright. "Combined with the recent price declines of key commodities for the Canadian economy, we expect the Canadian dollar to weaken to 85.5 US cents by the end of 2006 and to 81 cents US cents by the second half of 2007."
At the same time, the U.S. Federal Reserve is winding down its 16 successive rate hikes which pushed the Fed funds rate to five per cent from one per cent in June 2004. With a slowing U.S. economy but core inflation still rising, RBC expects the U.S. Federal Reserve to hike the policy rate two more times bringing the funds rate to 5.5 per cent for the balance of the year.
A complete copy of the forecast is available as of 8 a.m. E.D.T., at