The Canadian economy will likely outpace the U.S. economy again in 2003, expanding by 3.7% in real terms, followed by a 3.5% real growth pace in 2004, according to economists at RBC Financial Group.

“Consumers will remain the cornerstone of Canada’s strength, supported by robust job growth as well as the continued release of some of the remaining pent-up demand accumulated during the leaner years of the 1990s,” it says in a new report, the January 2003 Economic and Financial Market Outlook.

“Solid above-potential growth will keep the Bank of Canada on high alert for signs that the economy is breaching capacity with the associated threat of mounting inflationary pressure. Although the recent spike in prices was the work of more transitory forces that are expected to wash out of the data by early 2003, the Bank of Canada remains firmly committed to removing the excessive amount of monetary stimulus in a timely fashion,” RBC observes.

It predicts that the Bank of Canada will resume hiking interest rates in April. “By the end of 2003, the overnight interest rate will have climbed to 4.50%.”

“With the Fed lagging behind the Bank of Canada’s lead, the spread between Canadian and U.S. interest rates is expected to balloon to 200 basis points by the end of the year. This, together with upward pressure on commodity prices and an expected easing of financial market uncertainties, will help lift the loonie to 68 U.S. cents by the end of 2003,” it says.

The outlook for the U.S. economy this year will be more reliant on how the business sector responds to a slower sales environment and heightened uncertainty on the world stage. “The conditions that underpinned buoyant consumer spending for most of last year are expected to remain in place. However, consumers are expected to ease back on the throttle as signs of overspending in the past few years begin to catch up with households. Once uncertainty ebbs, improving business fundamentals should begin to take over and allow businesses to resume the nascent business recovery that was cut short mid-way through 2002.”

RBC sees real U.S. GDP growth of 3% this year, followed by a gain of 3.6% in 2004 as economic activity broadens out from the consumer base to incorporate the business sector. “Industrial bottlenecks are not expected to develop as excess capacity should remain in place right to the end of 2003 with only little excess demand emerging in 2004. Core inflation is expected to peak at 2.3% next year,” it says.

“Under these circumstances, the U.S. Fed is expected to remain on the sidelines for some time and will only begin to normalize exceedingly loose monetary conditions in September of this year once growth momentum becomes clearly established. The Fed funds rate is expected to finish 2003 at 2.5%,” RBC concludes. “The risks to the outlook and interest rates, however, are tilted to the downside in the near-term as modest growth prospects and business confidence could keep the economy in a ‘soft-patch’ for a longer period of time.”