Canada’s economy has been battered and bruised by a variety of shocks, but the effects will wane in the coming quarters, say TD economists.

The Canadian economy suffered during the second quarter as it felt the impact of a stronger Canadian dollar, SARS, the U.S. ban on Canadian beef exports, the power outage in Ontario, forest fires in British Columbia.

While those events will limit the ability of the Canadian economy to bounce back in the third quarter, “Canada’s economic fundamentals remain healthy and there is every reason to believe that the worst is behind us,” said Don Drummond, senior VP and chief economist at TD Bank Financial Group.

Drummond made his comments in conjunction with the release of the September issue of the TD Quarterly Economic Forecast.

TD economists stress that the economic shocks are only short-term disruptions to economic activity and that their effects will wane, setting the stage for a rebound in economic growth and job creation.

“One particularly encouraging sign for the Canadian economic outlook is the concrete evidence that the U.S. economy is finally turning the corner,” noted Drummond.

U.S. economic growth is expected to rebound to an average of 4.6% in the second half of 2003 and to average 4.2% in 2004.

With 87% of all Canadian exports destined for the United States, there is no question that the Canadian economy will benefit from a rebound in U.S. growth, but the boost will be limited by the impact of the stronger Canadian dollar, which TD forecasts will strengthen to US76¢ by the end of next year.


“While Canadian and U.S. economic growth will rebound, inflation will not become a problem,” said Drummond. TD economists predict that inflation in both countries will trend lower over the next few quarters and will only gradually increase in the second half of next year.

Although the risk of rising inflation appears minimal, the likelihood of continued strong economic growth, tighter labour markets and less economic slack in 2005 is expected to lead to central bank rate hikes before the end of next year. “However, the Bank of Canada and the Federal Reserve will take a measured approach, ensuring that they do not put the economic recovery at risk,” suggested Drummond.

The Bank of Canada is expected to begin tightening policy in the second half of 2004, with two quarter-point rate hikes in both the third and fourth quarters. The Fed is likely to be slower off the mark, delivering 25 basis point rate increases at their November 10 and December 14 of 2004.

The economic growth and inflation outlook has important implications for financial markets. Money market rates will remain pinned at historically low levels until the central banks begin tightening monetary policy.

In contrast, bond yields will gradually trend higher over the forecast horizon, but the continued low inflation environment will limit the extent of the rise. Meanwhile, the stronger economic conditions should help fuel high single digit increases in Canadian and U.S. corporate profits over the next six quarters.