The IMF in January predicted that Canada would have the highest growth rate of the G-7 countries this year, and this expansion accelerated sharply during the first quarter. The Bank of Canada is now projecting 3.7 per cent output growth this year and 3.1 per cent in 2011.

Recession and rebound. The Canadian recession last year was broadly comparable to the U.S. slump. Real GDP contracted by 3.9 per cent from peak to trough compared to 3.8 per cent in the United States. The decline in industrial production was somewhat worse: Production fell 16.4 per cent against a 14.3 per cent U.S. fall. This discrepancy is attributable to the auto sector, where output fell 35 per cent from its peak in early 2007.

However, the Canadian economic rebound looks set to be stronger than that in the United States, in part because households were less overleveraged, a housing bubble avoided and the financial system less burdened by problematic assets.

Sources of strength. The Canadian upturn is broad-based:

  • Real consumer spending will increase by 2.7 per cent in 2010, compared with 0.2 per cent last year.
  • Private fixed investment will rise by 6.4 per cent, after a 14.1 per cent contraction in 2009.
  • Exports will jump by at least 7 per cent, recovering from last year's 14 per cent tumble--despite a strong loonie (a coin worth one Canadian dollar).
  • Recovering exports will reduce the current account deficit to $15 billion Canadian ($14.6 billion) this year and $9 billion Canadian next year, a vast improvement on the $41 billion Canadian shortfall of 2009.
  • The unemployment rate will dip to 7.8 per cent this year and 7.2 per cent next year, from 8.3 per cent in 2009.

Areas of continuing weakness. However, there are several areas of continued economic softness, which could be a concern going forward:

  • Trade. Foreign trade played a major role in the Canadian downturn, and the recovery in exports is being slowed by the strong loonie. The United States' imports of Canadian goods fell 28.2 per cent in 2009, the United Kingdom 7.1 per cent and Japan 25.0 per cent.
  • Housing. There was also a downturn in the housing sector, although it was not nearly as severe as the U.S. collapse. However, the recovery has been very uneven regionally. Starts in Ontario rebounded to 59,600 from a trough of 34,300 last April, while in British Columbia they have surged to 22,100 from a low of 9,100 in March 2009. This upswing has been accompanied by an upturn of prices in some cities.
  • Auto industry. The 2009 downturn was very severe in the auto industry because of the weakness of exports. Motor vehicle production fell to 1,425,000 from a 2000–08 average of 2,590,000. The auto share of Canadian exports has fallen to 12 per cent from 25 per cent two years ago. However, most economists and the industry itself expect that auto output will rebound to 1,900,000 this year and 2,200,000 in 2010.
  • Persistent unemployment. Unemployment remains high, though it is more severe in the populous eastern provinces than in the west.

Monetary outlook. As real GDP is expanding at a rapid 5 per cent annual rate during the first half of 2010, there is now a broad expectation in the markets that the Bank of Canada will raise interest rates during June rather than waiting until July. However, inflation is not yet a major issue, and the Bank expects that it will rise slightly above 2 per cent before returning to target next year. Annual inflation was 1.4 per cent during February, while core inflation fell to 1.7 per cent from 2.1 per cent.

Exchange rate. The most significant challenge for Canadian monetary policy will be the country's exchange rate. The Canadian dollar is already close to parity with its U.S. counterpart, and could easily rally to its November 2007 high of $1.10 Canadian. As Canadian business wants the exchange rate to remain closer to 90 U.S. cents, the risk of exchange-rate appreciation could slow the speed at which the Bank raises interest rates. However, in the absence of such constraints, the Bank's likely rate target for mid-2011 should be approximately 3.0 per cent.

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