Canada’s good economic fortune is expected to extend into 2003 as it will continue to be the G7 growth leader, predicts RBC Financial Group’s economists. The U.S., however, are expected to experience more modest growth, led by a return of business spending.

RBC forecasts 4.1% growth for Canada in 2003 and around 3% for the U.S. This follows an expected growth of 3.6% for Canada in 2002 and 2.5% in the U.S.

“The pervasive sense of gloom and doom is obscuring the solidity of the groundwork laid for stronger growth in North America – particularly in Canada,” said Craig Wright, chief economist at RBC Financial Group today in a release. “Many are pondering how long Canada’s success compared to its southern neighbour can last. But the forces that have combined to make Canada’s standout performance this year are far from fleeting and the good news story is set to carry over into next year.”

The roots of Canada’s stellar performance lie in monetary policy decisions made two years ago that have ensured plenty of homegrown support for the economy. “Even if the U.S. engine continues to sputter, the Canadian economy can hum along,” said Wright.

Canada’s strong recovery has overshadowed the reasonably good performance of the U.S. economy and its improving prospects. “Caution on the part of businesses has left a gaping hole in the U.S. economy that a year’s impressive wave of consumer spending has only partly offset,” said Wright. “But finally we’re seeing signs that businesses are ready to join consumers – and not a moment too soon. While the enthusiasms of U.S. consumers to spend should never be discounted, the signs are there that they have started to tire.”

Canadian businesses have been gearing up for the next leg of the business cycle, hiring workers and beefing up capital expenditures, activities that will continue in 2003. Canadian consumers are also in better shape to keep spending than their U.S. counterparts. They are benefiting from a stronger labour market and a boost in wealth effect stemming from Canadian household’s higher percentage of capital held in superior-performing real estate assets.

As a result of Canada’s out-performance of the U.S., pressure for inflation are likely to develop in Canada first, notes the report. RBC anticipates that by the end of next year the overnight interest rate will have climbed to 5%, while Canada’s inflation rate will top out at the ceiling of the Bank of Canada’s 3% inflation target.

In the U.S., a less robust recovery is expected to delay the first rate hike by the Fed to the mid-point of next year. A series of hikes in the second half of 2003 will leave the Fed funds rate at a relatively low 3% by the year end.

According to the RBC outlook paper, the Canadian dollar will appreciate to 70.4¢ US by the end of 2003 because of stronger world growth and a bounce in commodity prices. However, a high degree of geopolitical uncertainty might impose a considerable amount of risk for the Canadian dollar. RBC economists assure that the ride up will be “anything but smooth.”

The report cautions that the degree of uncertainty underlying the forecast is “unusually high” due to the threat of war in the Middle East and the stream of headline news generated by bad corporate governance. “However, although risks at the moment seem evenly balanced between stagnation and recovery, we think that sufficient groundwork has been laid for a return to stronger growth in 2003.”