BMO Nesbitt Burns says that Canada’s economic lead over the United States is starting to narrow according to Dr. Sherry Cooper, chief economist at BMO Nesbitt Burns.

Canada’s growth pace was the strongest in the G-7 last year. In a briefing issued Monday, Cooper said that the economy’s performance was boosted by a red-hot housing market and record domestic auto sales. “A repeat performance is likely this year as well, although the gap between Canadian and U.S. economic growth is likely to narrow,” she said.

“To be sure, risks remain as the Iraqi situation continues to loom large over financial markets, the U.S. prepares for possible terrorist attacks, and North Korea plays a dangerous game of nuclear brinksmanship. But the underlying fundamentals are pointing to a marked improvement in the U.S. economy. Corporate earnings are rebounding and corporate default risk has declined,” Cooper said.

Cooper added that consumers are tapped out on both sides of the border, so fate of the U.S. economy rests with the business sector. She noted that “Free cash flow is rising and profit margins have improved. In both countries, inventories are finally starting to rebound, although American companies are far more cautious about restocking shelves. This is surprising, given the huge excess capacity that remains in the U.S. basic industry sector, not to mention the tech industries. In stark contrast, Canada is running at better than full capacity in the industrial and resource sectors and profits there are surging.”

Cooper said that investment in capacity-enhancing capital is still very weak, but that it has seen a significant revival in productivity-enhancing investments in computers, peripheral equipment and software.

Cooper predicted that the U.S. dollar, though vulnerable, will not collapse. She added that deflation fears appear to have run their course.

“The major risks remain geopolitical, and there the uncertainty is laced with the perils of an Iraqi invasion that doesn’t go well. Hopefully, in the next several weeks, much of that uncertainty will dissipate and the positive underlying fundamentals will show through,” she concluded.