Economic growth will likely drift lower in North America, Europe and Japan over the next year, according to a new economic outlook from Bank of Nova Scotia.

In the report, economists at Scotiabank note that although U.S. consumers are still in a shopping mood when it comes to housing, they have begun to curb spending and borrowing in other areas.

A further deterioration in the trade deficit and a softer trend in industrial production also point to somewhat slower growth, Scotiabank says. On balance, the U.S. economy will likely expand at an annual rate of about 3 1/4% during 2005-06.

“Canada and Mexico, which rely on U.S. locomotion to top up domestic spending, will experience a similar softening in overall performance,” says Warren Jestin, Scotiabank’s chief economist. “While Canada is receiving an added boost from booming natural gas exports, non-energy earnings have been hit by our dollar’s 30% appreciation over the past three years. The net result — Canada will be the NAFTA zone[s economic caboose, lagging U.S. growth by over half a percentage point through 2006.”

Economic drift has become increasingly prevalent in Europe and Japan. Activity has softened in the U.K., and uncertainties regarding the outlook have intensified in the aftermath of the early-July terrorist attacks in London. However, Scotiabank says its expects the U.K. to continue to outpace the euro zone, where growth will probably not average much more than 1.5% through 2006.

Scotiabank economists note that Japan’s spurt out of recession has already begun to sputter, keeping the economy in the growth cellar. The pace of activity in China, India and other parts of Asia also is likely to move onto a lower glide path, though the performance gap between Asia and the mature G7 economies will stay very wide. Latin America will continue to lag these world pace setters.

On the inflation front, excluding the influence of volatile commodity swings, Scotiabank says core consumer price pressures should remain non-existent in Japan and hover around 1.5% in Europe. In North America, inflation trends will mirror relative growth prospects, with core consumer prices advancing slightly over 4% in Mexico, just below 2.5% in the U.S. and less than 2% in Canada.

Even in rapidly growing economies such as China and India, consumer price trends are well below those experienced during the 1990s, Scotiabank says.

With inflation in check, the potential for a big run-up in interest rates appears to be remote. Scotiabank says the U.S Federal Reserve is probably within half a percentage point of pausing in its year-long phase of nudging short-term interest rates higher.

“Back home, the Bank of Canada has officially stated that interest rates eventually will rise and will probably move to fulfill this prophecy with a modest reduction of monetary stimulus after Labour Day. However, our inflation and growth fundamentals suggest that the central bank will stay largely on the sidelines over the next year, particularly if the Canadian dollar moves above US85¢. Both short- and longer-term Government of Canada bond yields are expected to remain below comparable U.S. levels,” says Jestin.

Turning to the provinces, Scotiabank says B.C. will remain a top performer this year and next, bolstered by its strong natural gas, coal and metal mining industries. Drilling activity and petroleum-related investments will keep Alberta on the fast-track, with crude oil prices expected to average more than US$50 a barrel through 2006.

Ontario should post output growth around the 2% mark this year and next, reflecting the multiple challenges of a stronger Canadian dollar, high energy and other input prices, intense competition from low-cost overseas products, and moderating U.S. growth.

Machinery & equipment investment, electricity projects and infrastructure spending are expected to maintain real GDP growth in Quebec of just over 2% through 2006.

Newfoundland & Labrador’s economy should rebound as exports are boosted by the start-up of the province’s third oil field, White Rose, and the Voisey’s Bay nickel project.