The Canadian economy has largely stalled as a result of the worsening credit crunch and the slumping U.S. economy that has robbed manufacturers of their traditional market, the Bank of Canada says.
The assessment in the central bank's quarterly monetary report gives a clearer understanding of what the bank's governing council was weighing Tuesday when it slashed its key interest rate by half a percentage point to three per cent.
After predicting in January that an upturn would begin this quarter, the bank now says Canada has entered an economic flat spot with growth in the current quarter barely above recessionary levels at a 0.3 per cent annualized rate, and won't recover fully until 2010.
The bleaker outlook for the economy comes amid other potential bad news for Canadian consumers:
-CIBC World Markets predicted Thursday that national average gasoline prices, now about $1.23 a litre, will top $1.40 this summer and $2.25 by 2012 as crude oil prices continue to soar and reach US$225 a barrel in four years.
-The country's largest bread maker, Canada Bread Co. (TSX:CBY), warned that consumers can expect to pay more for bread, bagels and other flour-based products after a 32 per cent drop in first-quarter profit amid "significant margin compression due to rising wheat prices."
But Bank of Canada governor Mark Carney said Canada won't fall into recession thanks to the relatively strong internal economy buttressed by oil and mineral exports and the record number of Canadians who have jobs.
"The decline in exports ... is counterbalanced and in our view more than counterbalanced by the strong domestic demand," he said.
Still, Carney noted that the bank will likely have to put more stimulus into the economy over and above the 1.5 percentage points it has cut from the overnight rate since December.
Part of the reason is that tight credit conditions have increased the cost that the chartered banks pay for capital, causing them to pass on only a portion of the central bank's stimulus to businesses and individuals in the form of lower borrowing costs.
The Bank of Canada estimates that commercial interest rates are up to three-quarters of a point a higher than might otherwise be the case given the bank's monetary actions. As well, obtaining credit has become more difficult, particularly for businesses.
"There has been a tightening of credit, but certainly it's much better in Canada in this situation than it is in the other major economies," Carney said.
He said Canada's banks have not seen the same elevated funding costs as in the U.S. and are better capitalized, which has allowed them to lend more broadly.
While it was reluctant to use the word recession, the bank said the American economy will contract slightly during the first half of this year, before growth resumes thanks to the tax-rebate package passed by the U.S. government, lower interest rates and higher exports encouraged by the weak greenback.
Still, the advance will be weaker and take longer than first thought, and that will prevent Canada, which sends about 75 per cent of its imports to America, from mounting a quick recovery.
The U.S. slump is also dragging on global growth, projected at 3.7 per cent this year and 3.5 per cent next, well below last year's 4.9 per cent advance.
"These global developments will have consequences for the Canadian economy," the bank says.
"First, exports are projected to decline this year. Second, turbulence in financial markets will continue to make financing in capital markets more costly and difficult for Canadian businesses and banks. Third, business and consumer sentiment in Canada is expected to soften somewhat."
The bank says credit conditions and the Canadian economy won't return to normal until late 2009 or possibly 2010.
As it reported Tuesday, the bank has scaled back its growth projection for the Canadian economy to 1.4 per cent this year and 2.4 per cent next, then 3.3 per cent in 2010.
The bank also expects Canada's inflation to remain below two per cent for the next two years and looks for commodity prices to slip about 15 per cent and oil prices to drop to just $100 US a barrel in the next two years as global demand cools.
One strength in the Canadian economy continues to be housing - a key difference from the United States.
"Demand should ease, since affordability has deteriorated and economic growth is expected to slow," the bank says.
"However, a general reversal in house prices is unlikely as there are few signs of excess housing supply."
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