The preconditions for a gradual revitalization of global activity are falling into place according to a new report from Scotia Ecomics.

“Interest rates are hovering near generational lows and should stay there because inflation is minimal and going nowhere fast,” said Warren Jestin, Scotiabank’s chief economist. “The process of repairing balance sheets and resuscitating earnings is well under way. Inventories in many industries are under tight control. The worst of the valuation excesses also have been wrung out of global equity markets. Even though G7 growth may temporarily falter, the revitalization process should begin to get back on track by summer.”

For Canada and the U.S. this will not be a return to the fast track. Former engines of growth, the high-tech sector and business investment, are still largely dead-weight baggage, and will remain that way through much of 2003. Financial markets are still suffering a lingering hangover from the late-1990s’ bubble. According to Jestin, “investor expectations have been resized to incorporate the prospect of slower growth, lower interest rates and leaner profits.”

For businesses, the absence of strong revenue momentum and the inability to pass on higher input costs have triggered repeated rounds of cost crunching to bolster profitability. For investors, cumulative big stock market losses compounded by periodic market spasms have reinforced a preference for safe, liquid investments. And for increasingly indebted consumers, hefty discounting and low interest rates are needed to keep them in a shopping mood.

“Even governments are being pushed to resize agendas as softer revenue growth has closed the window for deficit-free stimulus,” said Jestin.

Canada has led G7 nations in growth over the past four years and is the only member with twin fiscal and trade surpluses. Even here, however, government balances are being eroded by slower growth, previous multi-year tax cuts and renewed spending largesse. “For Ottawa in particular, the fiscal room to accommodate fully the recent plethora of ambitious proposals dealing with health care, education, infrastructure, defense and the Kyoto Protocol is quite limited,” added Jestin.

Looking ahead, Canada should retain G7 growth leadership in 2003 but will be increasingly challenged by the U.S. as the year wears on and our job creation machine loses steam and our appetite for big-ticket items begins to recede.

“Monetary policy is also less aggressive here, in large part because our economy has been performing better,” said Jestin. “With cost-crunch business practices and cost-conscious shoppers holding down inflation, the Federal Reserve won’t begin lightening up on the accelerator until there is a demonstrated material improvement in U.S. and global economic conditions. At best, the Bank of Canada’s stated intention to withdraw some of the exceptional stimulus provided after the September 11th attacks won’t get in gear until the U.S. embarks on a similar course.”

The Canadian dollar has shown little direction against the American currency despite much better growth, trade and fiscal fundamentals. More of the same is likely, although a slight upward tilt to the loonie may emerge if the American dollar loses a bit more altitude.

“All in all, 2003 is shaping up to be a good year, but not a great one for Canada and the U.S. The process of recovery and revitalization is still far from over,” concluded Jestin.