The credit crunch may be fading, but a weak economy will keep borrowing constrained for some time yet, TD Economics says in a new report.

TD notes that household borrowing dropped to $13.8 billion in new funds in the first quarter compared with $25.6 billion for the previous quarter and $21.3 billion in Q1 2008.

“Sluggish borrowing in mortgages was the main contributor to the reduced pace, as new mortgages increased at half the pace recorded in the previous quarter,” it explains.

It also notes that other forms of household credit weakened too, as consumers reined-in expenditures on durable goods during the quarter. That said, overall consumer credit continued to grow, TD says, albeit at a much lower pace.

Business borrowing was weaker too. TD reports that new financing for non-financial corporations fell to just $6 billion in new funds during the first quarter, down from $14 billion in the previous quarter and from $20.6 billion in Q1 2008. “The weakness originated from smaller corporate profits and a reduced change in retained earnings through which to finance new investment internally,” it says.

TD suggests that the contraction in output in Q1 is “likely the most severe that Canada will face during this recession”. However, it adds that the improving economic data only shows that the rate of decline is moderating, not that growth has resumed. It expects that output will continue to contract until the fourth quarter.

“Even with attractive borrowing rates, facing a grim 2009 of higher unemployment and dampened income growth, uncertain households are likely to delay home-buying and other big-ticket purchases,” it says.

And, business borrowing will likely remain restrained too. “With falling sales intensifying pressures to draw down current inventories, manufacturers and wholesalers will be increasingly queasy about putting new stock on their shelves. With machinery and equipment going idle and the output gap widening, new business investment will continue to slow until mid-2010,” it says.

“All indicators therefore point to diminished demand for credit — a trend that will continue through 2009,” TD concludes. Credit supply may also be constrained as lenders scrutinize borrowers more closely in the weak economic environment.

“Credit flows should be expected to subside further — at least until the widely postulated ‘green shoots’ are actually firmly rooted,” it concludes.