Expectations about economic and financial market prospects are being resized to incorporate slower growth, lower interest rates, leaner profits and a longer recovery according to Warren Jestin, Scotiabank’s chief economist.

“Investor confidence has been shaken by concerns about the outlook for profits, capital spending as well as blockbuster cases of corporate malfeasance and heightened geopolitical tensions,” said Jestin, in a news release. “While next year’s overall growth performance in North America will be respectable, the revival in household demand has recently stumbled in Continental Europe, is showing signs of fatigue in the U.K. and remains depressed in Japan.

“However, with interest rates anchored at historically low levels by the virtual absence of global inflationary pressures, the expansion is expected to gradually broaden and deepen over the next year,” added Jestin. “Inventory excesses have been brought under control and global industrial production has been strengthening since December, helping to resuscitate international trade and commodity markets. The strongest performances have been recorded by Canada and the United States, where inventory rebuilding has supported growth and industrial output has surpassed year-earlier levels.”

Canada is expected to remain the top G7 performer through 2003. This year’s fast start puts domestic growth on track to average nearly 3.5%. Canada’s performance edge is underpinned by a competitive exchange rate and solid domestic demand. While softer foreign markets may limit export gains, consumer spending will be bolstered by heavy price discounting, low borrowing costs and record job creation in the first eight months of 2002.

Federal Reserve Board Chairman Greenspan’s concerns about financial market volatility and its potential effect on economic activity suggest that U.S. monetary policy will be on hold into next year. “Canadian interest rates have followed a different course, with the Bank of Canada reacting to more buoyant conditions by raising the benchmark rate three-quarters of a percentage point,” said Jestin. “Governor Dodge has indicated that he intends to reverse gradually the two percentage point drop in rates put in place after September 11th. However, the decision to defer raising interest rates at its policy meeting in early September suggests that the central bank has adopted a go-slow approach until financial turbulence subsides.”

Exchange rates remain choppy. The U.S. dollar edged lower against other major currencies in the first half of 2002, but has since shown considerable resilience. While further erosion may occur in 2003, the uncertain economic and geopolitical situation beyond North America’s shores should forestall a major correction. The Canadian dollar has rebounded from record lows against the American currency, bolstered by wider Canada-U.S. interest rate differentials and Canada’s relatively stronger economic fundamentals. However, as a secondary currency closely tied to U.S. developments, further erosion of the U.S. dollar may benefit the Canadian currency less than offshore alternatives.

Looking across Canada, the offshore petroleum sector continues to underpin East Coast growth, bolstering exports, job creation and new investment. Significant energy spending also buoys the outlook for the West, with Alberta commanding the lion’s share of this activity. An uneven U.S. recovery and soft markets abroad are expected to restrain Quebec’s and Ontario’s expansion entering 2003. Mexico’s increasing alignment with U.S. trends has insulated the country from much of the economic and financial turbulence in Latin America. However, the pace of activity is being restrained by consumer caution. Japan’s economy has been unable to sustain any forward traction. The major countries of the Euro zone have been unable to generate faster growth. While growth should strengthen gradually into 2003, fiscal constraints and a cautious monetary policy limit the potential for government pump priming.