Bank of Nova Scotia economists have raised their GDP growth forecasts for Canada and the United States this year, but don’t see interest rates rising until the second half of 2010.

In a research note issued today, Scotia’s economists raised their already above-consensus forecasts for 2010. The forecast now calls for U.S. output to rise by 3.6% this year, up from its previous call for a 3.3% gain. The forecast for real GDP in Canada has also been lifted 0.3 points to 3.0%. And, it is now looking for a 4.0% gain from Mexico, up 0.6 percentage points from its previous forecast.

“A stronger first-half growth performance is evolving in the United States, building upon the improved year-end gain that we had anticipated. U.S. domestic activity is expected to get a bigger boost from increased consumer spending, in response to improving employment conditions, rising incomes, and a rebound in household wealth. We now expect U.S. business investment in machinery & equipment to add to growth in 2010,” Scotia Economics says.

“Industrial activity is forecast to gain momentum as the global inventory cycle kicks into a higher gear. Increased consumer spending and residential housing activity are driving the upward shift in Canadian growth prospects, while an accelerated pace of manufacturing and exports is behind the stronger rebound now expected in Mexico,” it explains.

Scotia says that the U.S. economy is expected to be much less reliant on households to generate growth. It says consumers will contribute about 50% of the GDP gain, whereas between 2002 and 2007 consumer spending accounted for about 75% of the total. “In contrast with the prior growth period, net exports will add to, not subtract from, growth,” it says.

In Canada, consumer spending is expected to deliver just under 60% of GDP growth, but net exports should continue to subtract from domestic growth “the result of longstanding competitive issues linked partly to a strong currency.”

Looking further out than this year, Scotia says that the U.S. economy “will continue to be restrained by the structural headwinds associated with reducing household debt, industrial consolidation and restructuring, a more restrained pace of credit expansion, and increasingly down the line, a rising tax burden. Accordingly, we continue to expect U.S. output growth to slow in 2011, with real GDP forecast to expand by an average of 2.6%.”

The bank’s views on interest rates remain unchanged. “We continue to expect that the central banks in the U.S., Canada, and the Euro zone will begin the process of gradually normalizing short-term borrowing costs in the third quarter, with the U.K. and Japan following in the final quarter of 2010 and the first quarter of 2011, respectively. “Look for the Fed and the Bank of Canada to raise their benchmark overnight rates a total of 2 percentage points to 2.25% by mid-2011, and then keep them on hold. A similar pattern, though smaller cumulative rate increases, is likely in Europe and Japan,” it says.

In addition to the revisions to its North American forecast, Scotia also made minor upward adjustments to this year’s real GDP outlook for Germany and the UK, and it noted that output gains in China and India are expected to lead the way, averaging 9.5% and 7.0% respectively in 2010. Recent moves to restrain domestic credit conditions will contribute to a modest deceleration in activity next year, it says. “In 2011, we anticipate that China’s real GDP growth will average a still-strong 9.0%, with India’s advance pegged at 6.5%.”

IE