BMO Nesbitt Burns says that Canada’s higher growth, higher inflation performance could reverse itself by next year.

In a report published Thursday, Dr. Sherry Cooper, Nesbitt chief economist says that there has been a sea change in U.S. financial policy in the past two weeks. “The tacit acceptance of a weaker U.S. dollar, coupled with the stated concern that inflation is too low, is a marked and seminal break with the U.S. policy of recent decades. It likely means that interest rates will remain lower for longer than we had earlier expected,” she says. “It is a boon to the U.S. economy and stock market. It runs enormous risks, however, of destabilizing the global financial system.”

“The past decade has witnessed a U.S.-centric global economy. If the dollar were to fall meaningfully further, the external side of the Canadian, European and Japanese economies would be dampened significantly. This sector has been the driving force for global expansion,” says Cooper. She notes that China is the only big country that will not be hurt by this, rather Chinese exports to countries outside of the U.S. become even cheaper and more competitive. “Canada already has its largest trade deficit with China, and it will only get larger,” she predicts.

“The irony is that while Canadian core inflation is now running well above the level in the U.S., by the end of next year, core inflation in Canada could be below the level in the U.S. Much of the surge in Canadian core inflation in the past year can be traced directly to the 30% spike in auto insurance premiums, which is not expected to persist beyond this year. Moreover, the strength of the Canadian dollar will dampen underlying inflation trends in Canada, while the weak U.S. dollar will boost U.S. core inflation,” she says. “In addition, overall fiscal and monetary policy is much more stimulative in the U.S. than in Canada. This will lead to stronger American growth in 2004 relative to that in Canada for the first time since 1998.”

Cooper says that the weaker U.S. dollar will contribute to the enhanced competitiveness of American companies and higher profits for foreign operations of U.S. multinational corporations. “Hardest hit in Canada will be the export-driven sectors such as forest products, energy, metals, auto parts, steel, and transportation,” she notes.