The Canadian economy is poised to strengthen, but the fallout from the surging Canadian dollar will dampen its performance in 2004 and is likely to prompt the Bank of Canada to cut interest rates early in the year, say TD Economists.

The economy will sustain the stress of the strong loonie and grow by “a respectable, but not stellar, 2.8%” in 2004, according to the bank’s quarterly outlook released Tuesday.

The TD report forecasts that the Bank of Canada will likely cut short-term interest rates by half a percentage point in the first two months of next year.

The strong currency will weigh on export-oriented manufacturing and will cause job losses in that sector, but the domestic economy “remains fundamentally sound, with the service sector to continue delivering a robust performance.”

“There is nothing inherently wrong with the Canadian dollar at US76¢ or even higher,” said Don Drummond, chief economist at TD Bank Financial Group.

“Indeed, the stronger Canadian dollar is unambiguously positive for consumers and importers, but it will be a major challenge for exporters and Canadian firms competing with U.S. imports.” However, businesses will eventually adjust to the new exchange rate reality. It will just take some time.

Real gross domestic product will grow at a modest annualized rate of 2.7% in the first quarter of 2004 and 3% in the second quarter.

“Given that the Bank of Canada has hinted that it will ease monetary policy unless economic growth comes in ‘solidly’ above its long-term potential pace of three per cent, the outlook suggests that the central bank will lower interest rates in early 2004,” said Drummond.

TD economists predict that the central bank will reduce interest rates by a quarter point on Jan. 20 and again at its March 2 policy setting.