The process of global economic revitalization is still under way, but it is being impeded by the intertwining of war in Iraq, financial market volatility and exceptionally weak business investment, according to a new report from Scotia Economics.

“In this challenging environment, growth is likely to centre around 2 1/2% in North America — roughly half the pace of the late 1990s — and significantly less than that in the overseas G7 nations,” saaid Warren Jestin, chief economist, Scotiabank.

Lacklustre growth and low inflation point to continued low interest rates in most industrial nations, with the potential for even further monetary stimulus in the United States and Europe before mid-year.

“Federal Reserve Chairman Alan Greenspan will keep U.S. monetary settings geared for growth until American activity and job creation pick up and international uncertainties subside,” said Jestin. “The story is much different in Canada, where a stronger economy and higher inflation have again prompted the Bank of Canada to nudge interest rates higher, gradually eliminating the emergency stimulus that was put in place after the September 11 attacks.”

A competitive exchange rate, a big dose of fiscal stimulus and pent-up demand for consumer durables provided solid support during 2001-02, underpinning stellar job gains on the Canadian side of the border at a time when many U.S. industries were resizing operations and downsizing employment. While Canada’s performance edge has begun to narrow, the continuation of impressive gains in employment, housing and big-ticket consumer purchases into February points to additional tightening by the Bank of Canada during the spring.

“The combination of rising interest rates and a stronger currency will dampen Canadian growth prospects over the next year, eroding or even eliminating our performance advantage vis-à-vis the United States,” added Jestin. “Adding up the pluses and minuses, Canada may still have a slight edge this year, but could lose the G7 sweepstakes to the United States in 2004 for the first time since 1998.”

According to Scotia Economic’s Global Outlook report, the U.S. economy will continue to be supported by substantial fiscal and monetary stimulus, though Canada should do better on consumer spending — because of pent-up demand and stronger employment gains — and probably slightly better on business investment as well. External trade will be negative to growth in both countries, with the risk that the drag will be bigger in Canada as a rising Canadian dollar cuts further into export volumes.

The strong upswing in home sales and construction last year propelled the recovery in Ontario and Quebec, bolstering related industries and encouraging downtown redevelopment as well as suburban expansion. The motor vehicle sector — Central Canada’s largest manufacturing industry — will likely experience a flattening of assemblies in 2003 and 2004, though auto parts production should continue to advance.

In Western Canada, surging oil and natural gas prices are encouraging conventional drilling activity, but non-conventional investment growth is expected to ease. Housing markets have been supported by the increasing urbanization of Prairie populations and strong international and interprovincial population inflows into Alberta and southern B.C.

Resource development continues to underpin Atlantic Canada’s expansion. Growth in Newfoundland and Labrador was boosted in 2002 by the Terra Nova startup, and the White Rose and Voisey’s Bay projects are proceeding. Gains in higher-paying employment combined with low mortgage rates will maintain Atlantic housing starts this year close to last year’s buoyant level.

On the international scene, Mexico’s economy should expand by almost 3% this year, after posting marginal growth in 2002, and gain further momentum in 2004.

The developing Americas will be hard-pressed to register any meaningful growth this year, though the longer-term outlook appears constructive.

Euro zone growth has stalled, dragged down by the renewed slump in Germany and France.

The softening in overseas shipments will keep a lid on growth for Japan until the global outlook brightens, with prospects for a broader domestic revival contingent upon a resumption in consumer and business spending.

Stimulative public policies are helping to keep domestic growth on the fast track through much of developing Asia. China will remain the region’s growth leader, with output gains expected to average around 8% through 2004.