BMO Nesbitt Burns sees an optimistic outlook for Canada’s economy and financial markets in the year ahead.

“It appears that it’s ‘all systems go’ for domestic demand in Canada, as we look for another year of nearly 3% growth in 2006,” says BMO Nesbitt in a research note. “This will vie with the U.S. for top spot in the G-7 league tables.”

“With the release of the fourth quarter GDP numbers, growth in 2005 matched that of the year before at just shy of 3% as the jobless rate fell to a 30-year low, capacity utilization hit very high levels and the Canadian dollar continued to rocket upward,” it notes. “Both the Canadian stock and bond markets outperformed the U.S. last year, continuing a pattern that manifested in 2003.”

Although, it allows that the heavy weighting of resource stocks in Canada accounts for much of the outperformance, particularly energy stocks, which have posted a stellar performance over the past few years. And, markets have pulled back as commodity prices have eased too.

“Remarkably, in this environment, core inflation has remained quite muted, even with the energy-induced surge in headline CPI,” it says. “Nevertheless, the Bank of Canada resumed its tightening moves last September, and we expect them to hike overnight rates at least two more times this year. With labour markets tight and labour shortages evident in many sectors, especially in the booming economies of Alberta and B.C., wage inflation might well follow last year’s surge in energy prices.”

“Even with the mildly inverted U.S. yield curve, and a relatively flat one in Canada, we will continue to enjoy solid growth, relatively strong profits, low domestic inflation, rising incomes and strong trade balances — clearly a sunny outlook,” BMO Nesbitt predicts.

It adds that Canadian financial markets will benefit from planned reductions in dividend, capital gains and corporate tax rates. “How much of this we will see from a weak minority government is a question, but the Liberals at this stage are likely unprepared to force an election anytime soon,” it says.

“The biggest risks to the outlook might well be external: the contractionary effects of avian flu in Asia and elsewhere, particularly if it were to become of grave human concern; political instability in so many oil-producing countries which could lead to at least a temporary mega-spike in oil prices; terrorism; U.S. political paralysis and rampant anti-trade sentiment in a mid-term election year; and U.S. consumers that might one day realize they are over-extended,” it notes.