Optimism about the near-term economic outlook in Canada and the United States is tempered by the prospects for slower growth in the second half of 2006 and into 2007, said TD economists in the December issue of the TD Quarterly Economic Forecast.


The report noted that Canada and the United States experienced strong economic growth in the third quarter of 2005, but sluggishness on the consumer front in September and October sets the stage for a weaker performance by both economies in the fourth quarter of this year.

However, the report added that growth should rebound in early 2006.

With the economies operating at full capacity, TD expects the Canadian and U.S. central banks to raise short-term interest rates to peaks of 4% and 4.75%, respectively, early next year.

TD said the Fed rate hikes are expected to lead to an inversion of the yield curve, with short-term rates rising above long-term rates.

Although such a development would likely spark fears of a recession, TD economists do not anticipate a hard landing for the economy.

TD Economics has been warning for several quarters that continued elevated energy prices, higher short-term interest rates and weaker housing markets are expected to produce a mid-business cycle slowdown in the U.S. during the second half of 2006 and the first half of 2007.

Today’s report said an inverted yield curve would only add to this view.

A U.S. slowdown would pose an external shock to Canada, leading to a period of weaker economic growth north of the 49th parallel as well.

TD expects that the Bank of Canada would likely respond by easing monetary policy, and precicted the economy would pick back up in the second half of 2007.

“For some time, we have been warning that the combination of continued elevated energy prices, higher interest rates and an eventual cooling of North American housing markets, particularly in the U.S., will lead to weaker economic conditions ahead. These elements are all falling into place,” said Don Drummond, senior vp and chief economist of TD Bank Financial Group.

The report is available on the TD Economics web site.