The Canadian economy may be gearing down, but it is not sputtering out according to TD Economists in the latest edition of the TD Quarterly Economic Forecast.

“In spite of the ongoing struggles of the U.S. economy to pull itself out of the doldrums, Canada’s economy is in remarkably good shape,” said Don Drummond, SVP and chief economist at TD.

Business investment is rising on the back of strong growth in corporate profits and consumer spending has been underpinned by the strongest job gains in almost 15 years. “Given the sour global environment, it does not get much better than this,” remarked Drummond.

Nonetheless, the TD economists note that it will not all be smooth sailing over the next few quarters. “The Canadian economy may be holding its own, but it is not an island, and recent U.S. economic indicators have been all but encouraging” noted Drummond. “The decision by the U.S. Federal Reserve to shave another 50 basis points off the Fed Funds rate in early November is evidence in itself that all is not rosy south of the border,” he said.

According to the TD economists, the U.S. economy faces three important roadblocks over the near term. First, in spite of aggressive cost-cutting measures, corporate profits have yet to turn the corner, and capacity utilization rates are falling – which does not bode well for business investment. “It will take some time for the business sector of the U.S. economy to shake off its cobwebs,” said Drummond.

Second, the bulk of the impact of low interest rates on purchases of interest-sensitive durable goods – such as autos – and housing has already been spent note the TD economists. “Because the Fed was so quick to pull the interest rate trigger in 2001, the interest-rate-fuelled boost to spending that typically allows consumers to satisfy pent-up demand coming out of a recession is what kept them going during the downturn this time around. That will keep consumer spending running at only a modest pace,” remarked Drummond.

And finally, there is a significant risk of a war with Iraq. A short-lived war would weaken economic growth somewhat in the first half of 2003, but would not substantially alter the overall picture. “However, any escalation of the conflict could lead to more dire economic consequences,” stressed Drummond.

“With its trading partner in the doldrums, it is difficult to see how the Canadian economy can go it alone for much longer,” noted Drummond.

In light of the substantial excess capacity in the U.S. economy, there is no reason for the Fed to start raising interest rates before August, note the TD economists. “However, the Bank of Canada’s choices are more iffy,” said Drummond. The Canadian economy is operating close to its capacity limits, and as a result, the Bank has less wiggle room. The Bank will start hiking before the Fed — in June — and by the end of the year, it will have raised rates by 125 basis points compared with the Fed’s 75. “The resulting 200 basis-point spread is another in the long list of fundamentals that should support the Canadian dollar,” concluded Drummond.