The Canadian economy will weather the fallout from the recent financial turmoil, although it will be dampened by the impact of a stronger Canadian dollar and weaker U.S. economy, according to the October issue of the TD Quarterly Economic Forecast.

“It’s easy to be pessimistic on the U.S. economy at the moment, given that the weakness in the housing market is far from over and lenders will likely cut back on the availability of credit in the near term,” says TD’s Deputy Chief Economist Craig Alexander.

However, the TD Economics forecast for U.S. economic growth is little changed, with 2% anticipated in 2007 and 2.4% in 2008. “Prior to the financial volatility in August, a significant slowdown in consumer spending was anticipated. Recent events simply make this more likely to occur,” says Alexander.

“Americans may scale back their spending on big ticket items – like autos and luxury items – but so long as people have jobs and real earnings continue to grow, the economic expansion will continue,” Alexander adds.

In Canada, the recent financial turmoil will have an impact, but the effect should be limited. “There is no reason for Canadian lenders to tighten their credit standards in a significant way, since they were never loosened like in the United States,” says Alexander.

However the recent financial volatility will have an indirect impact on the domestic economy. Demand for Canadian products will soften alongside the weaker performing U.S. economy.

The waning U.S. demand will be compounded by the rise in the Canadian dollar, which reached parity in September. Looking forward, the Canadian dollar is expected to average close to, or slightly above, parity over the next six months, but then trend down towards US95¢ by the end of 2008.

The appreciation in the Canadian dollar since the last fixed announcement date and the recent weaker U.S. economic data suggest that the Bank of Canada will stay on the sidelines on October 16th, but the risk of inflation remains, suggesting that the next move by the Bank is still likely a hike.

“Although the outlook is for continued growth in the North American economy, we are not dismissive about the downside risks. The odds of a U.S. recession are probably close to one-in-three, the highest since the tech bubble burst at the start of this decade,” says Alexander. If the U.S. outlook proves to be too rosy, then so is the perspective on the Canadian economy. The key vulnerabilities relate to the U.S. consumer, and this means close scrutiny is called for with respect to data releases on employment, income, spending and personal borrowing.