Cooling in U.S. housing markets foretells an imminent U.S. economic slowdown, say TD economists in a new forecast, and a softening in U.S. demand will dampen economic growth globally and in Canada.

“While high-flying energy prices and the lagged impact of Fed rate hikes will play a role in the U.S. economic slowdown, the main catalyst will be a cooling U.S. housing market and a diminution of the powerful real estate wealth effects that have been driving consumer spending in recent years,” said Don Drummond, senior vp and chief economist of TD Bank Financial Group, in a news release.

U.S. economic growth is projected to drop towards a 2% annual pace in late 2006 and early 2007.

The slowdown in the world’s largest economy will have global implications, with world real GDP growth dropping from 4.6% in 2006 to 4.0% in 2007.

According to the TD forecast, Canadian economic growth is expected to average 2.5% over the next year.

“The fallout from a weaker U.S. economy will be borne principally by exporters,” Drummond said.

The weaker U.S. economy will also impact financial markets, leading to a decline in bond yields and commodity prices, as well as slower corporate profit growth.

Volatility will be a dominant theme in financial markets as the economies weaken over the next few quarters and then gradually recover in 2007.

“The dominant theme is weaker times ahead, but it is critical to keep this slowdown in perspective. The economies are only expected to experience a softer pace of expansion, not a hard landing,” stressed Drummond.

Slower economic growth will also help to keep inflation pressures in check. Unemployment rates may edge up slightly, but they will remain low. And, even though interest rates have risen, they will peak at historically modest levels.

“Equities may struggle as corporate profit slows, but remember that the stock market has a long history of being a leading economic indicator. If the economies experience a soft landing, equities are likely to rally strongly in response to central bank rate cuts and once there is clear evidence that a hard landing will be avoided,” noted Drummond.

“The main message is that consumers, businesses and investors should be braced for a period of economic and financial market volatility. However, the economic weakness is expected to pass relatively quickly,” concluded Drummond.