The global economy is being reshaped by shifting currencies, soaring energy prices, the ascendance of ultra low cost producers in international markets and the transition to less simulative policy setting in the United States, according to report released today by Scotia Economics.

“NAFTA will lead the G7 by a wider margin in 2005, with Canadian and U.S. growth converging around 3%. Neither country will match Mexico, which is on track to win the NAFTA growth sweepstakes after a prolonged period of weakness,” says Warren Jestin, Scotiabank chief economist, referring to the bank’s Global Outlook report for October.

“Among the overseas G7 nations, activity is beginning to take a breather in Japan, and U.K. domestic demand will likely cool in the months ahead. Euro Zone activity has very limited upside potential against a background of rising energy prices, the prospect of further currency appreciation, ongoing fiscal constraints and continued caution in monetary policy.”

According to Global Outlook, there may be declines international growth leaders such as China and India, though output gains will still be more than double the average of the G7 nations.

“For Canada, exports hold the key to achieving 3% growth in 2005 because domestic demand is unlikely to accelerate. External trade has often been a big swing factor in our economic performance,” says Jestin.

With the surge in energy costs and reduced spending by consumers likely to restrain the pace of U.S. growth into 2005, inflation will be slow to revive. In this environment, Scotia Economics expects that the Federal Reserve will tighten monetary policy more gradually. By late-2005, it says the funds rate is expected to climb to 2.75% – 1 3/4 percentage points above its cycle low.

“Canadian inflation is expected to surpass the Bank of Canada’s 2% target by late 2005. While domestic growth, buoyed by the strength in the resource sector, may be slightly better than in the United States, a higher exchange rate will help keep domestic price trends below U.S. levels,” adds Jestin. “This will provide the central bank with latitude to tighten policy gradually as well, with the overnight rate expected to end next year at 3 1/4%, three-quarters of a percentage point above the current level.”

Turning to the provinces, with energy prices shifting higher, Scotia Economics forecasts growth over the next year will be more steeply tilted towards Western Canada. The upswing in non-energy commodity prices will have a broader regional impact, but secondary manufacturers, particularly in Central Canada, will face the additional headwinds of a stronger Canadian dollar and more moderate U.S. growth.