The economies of central Canada face a challenging year, said BMO Capital Markets today.

A strong Canadian dollar, high energy costs and a likely U.S. recession are putting pressure on the economies of Quebec and Ontario, while strong commodity prices are likely to push GDP growth up in all provinces west of Ontario, according to the latest edition of BMO’s provincial outlook, released today.

“Most provinces will see slower growth this year, but Ontario and Quebec will face the brunt of the weakness,” said BMO’s deputy chief economist Douglas Porter, adding that GDP in these provinces will likely fall below 1%.

A solid service sector is helping to offset the stress in Ontario’s manufacturing sector, said the report. “Beneath the surface lies a great disparity between the crippled manufacturing and sturdy services sectors,” said Porter. “A rising employment share in the services sector has helped to lower the province’s correlation with U.S. growth in recent years.”

Meanwhile, Ontario’s unemployment rate is higher than the rest of Canada for first time on record and its manufacturing sector shed 55,000 jobs last year, while its service sector added 146,000. The province’s GDP growth likely remained at 2.1% in 2007, but as the U.S. economy softens, BMO expects growth to fall to 0.9%.

The West, on the other hand, should fare quite well. Strong consumer and construction activity in British Columbia as the 2010 Olympics draw near will continue to help offset a decline in the forestry industry, according to the report. “The headwinds facing the forestry sector will persist into 2008, dragging growth down from an expected 2.7% to 2.5%,” said Porter. “But this will still leave B.C. among the strongest provinces in the country.”

As well, B.C.’s labour market remains tight with a near-record unemployment rate, which BMO said should help keep B.C. consumers spending in 2008. The report adds that B.C. is now projecting a $2.1 billion surplus for fiscal 2007-8, way up from original budget estimates of $400 million.

Also out west, while Alberta’s economy is still set to remain one of the top in the country, it won’t see the surging of the last few years, said the reports author, Robert Kavcic, an economic analyst at BMO. Higher-than-expected oil prices and stronger tax revenue are pushing up the province’s surplus, but higher royalties in the energy sector and a cooling housing market are expected to temper things a little. “We expect growth to decelerate this year from an expected 3.8%, but remain well above the national average at 2.8%,” said Porter.

Picking up the slack, according to the report, is Saskatchewan, where growth likely hit 4.9% in 2007 amid surging potash and uranium sectors and a white-hot housing market.

Newfoundland and Labrador likely unseated Alberta as the country’s growth leader in 2007 as output at the province’s three major offshore oil projects rebounded, BMO said. And robust construction spending will help offset a downturn in manufacturing for Nova Scotia.

All provinces are projecting zero balances or surpluses for fiscal 2007-8, except PEI. All told, the combined 10-province surplus is now pegged at $7.7 billion for fiscal 2007-8, down from $16.1 billion in the prior year, states the report.

“The regional disparity in Canadian economic growth will persist this year, as still-strong commodity prices support growth across most of the West, while a deteriorating manufacturing sector continues to plague Central Canada,” it concludes.