Royal Bank predicts domestic demand will offset downward pressures on the trade sector and help Canada’s economy grow by 3.5% this year.

“While the drag from net trade will linger in 2006, most of the impact has already been felt,” Craig Wright, the bank’s chief economist, said today in a release.

“Our strong dollar will not prevent Canada’s growth as the economy is expected to accelerate this year.”

Healthy investment in machinery, equipment and non-residential structures will be a key economic driver in 2006, the bank said in its latest economic forecast, thanks to robust corporate profits and a strong Canadian dollar making imports of machinery and equipment cheaper.

Consumer spending remains healthy, the report said.

“Pent-up demand from the 1990s, combined with wage increases and tax cuts and the Canadian dollar, point to consumer spending rising by 3.4% in 2006, outperforming the U.S.”

Oil and natural gas prices are expected to soften by the end of 2006, but remain high enough to sustain the investment boom in Canada’s fossil fuel producing provinces.

Canada’s dollar rose to US88.67¢ in March, the highest rate since November 1991, the bank noted.

“We don’t expect the dollar to continue to trade at such high levels and believe it will end 2006, a little lower, at US84¢,” Wright said.

Canada’s core inflation rate is expected to rise slightly above the midpoint of the Bank of Canada’s inflation target band of one to 3%, due to a buildup of excess demand in the Canadian economy.