The Canadian resource and service sectors will continue to boom in 2006, but manufacturers could face significant hurdles if the U.S. economy starts to slow, TD Bank economists warned in their semi-annual industrial outlook released today.

Industry held up surprisingly well in 2005, the bank said, despite a “perfect storm” of economic challenges.

Manufacturers invested heavily to meet a rapidly growing North American demand, allowing them to offset the damage caused by the high Canadian dollar, high energy prices and greater competition from low-cost producers in China.

TD economist Sebastien Lavoie said a closer look at manufacturing turns up reassuring signs that the sector is coping well under the circumstances. Against all odds, he said, manufacturing productivity grew at “an impressive rate” of more than 5% this year compared with the Canadian average of 1% for Canada, and profit margins largely held up.

Nonetheless, manufacturing undoubtedly suffered, the bank said, pointing to the reported decline of some 150,000 manufacturing jobs over the past three years and announcements of further layoffs in the automotive and forestry sectors.

Manufacturing survived the challenges this year by raising its efficiency and competitiveness. The high Canadian dollar helped lower the relative cost of imports, allowing plants to renew their technology and capital equipment at a lower cost. Canadian manufacturers further improved their efficiency by farming part of their work out to lower-cost suppliers in China.

The outlook is not as good for 2006, however. TD Bank expects the U.S. economy to slow significantly in the second half and into 2007, and that will damp demand for Canadian exports until 2007-08 at the earliest.

The automotive and forestry sector faces the biggest uphill battle because TD Bank expects U.S. demand for light vehicles and housing to decline meaningfully in the coming year. But it sees continued strength in areas such as machinery, electronics and equipment.

Canada’s other industries also have a mixed future.

TD Bank expects a continuation of the buoyant job market. Prices for crude oil, natural gas and base metals will fall by about 15% in 2006, but will remain high. The exception is gold, which is expected to buck the downward trend and keep rising.

The outlook for construction is mixed. Housing starts are projected to fall back by 10% as interest rates rise, but non-residential construction will rise. But the retail trade will suffer slightly, the bank predicts, as interest rates rise and consumer confidence dwindles.