Canada’s economic challenges are largely limited to the export-oriented manufacturing sector, rather than the domestic economy. As a result, Canadian economic growth will likely outperform that of its neighbor to the south in 2007.

“The Canadian economy isn’t out of the woods yet, but we can see the tree line,” stated TD Bank’s Chief Economist, Don Drummond, in a news release.

According to TD Economics, the Canadian economy will expand at an annual average pace of 2.4% in 2007, just mildly slower than in 2006.

The U.S., however, will see a more sizeable slowdown, as the housing market continues to soften. After the year-long contraction in housing, the recent deterioration in the sub-prime market was expected.

“Worries over the Chinese stock market and U.S. sub-prime lending have led financial markets to internalize something we’ve been saying for over a year – global growth is moderating,” said Drummond. “However, the bigger issue for the U.S. economy this year will be consumer’s reluctance to spend, not their inability to find a loan. Stagnant home prices in the U.S. will limit home equity and make consumers less inclined to make big purchases now.”

The housing market has been a drag on the U.S. economy for over a year and TD Economics expects to see that continue through the first nine months of 2007. “

The vulnerable areas of the Canadian economy remain those with exposure to external demand. In particular, the budding recovery underway in the export sector will remain limited by softening U.S. demand. “Canadian exports are expected to grow faster in 2007 than last year, but they still bear the markings of a relatively soft sector,” said Drummond. “However, as prospects in the U.S. economy improve later this year, so too will the fortunes of Canadian exporters and the Canadian economy.”

TD Economics expects the Canadian dollar to show little movement from its current level near YS85¢. “Manufacturers are still adjusting to the elevated Canadian dollar, but they won’t have to worry about new pressures coming from the loonie,” said Drummond.

The rest of the domestic side of the Canadian economy is cooling to an average pace. This will help bring inflation down to the Bank of Canada’s target level by the end of the year. “The Bank of Canada will remain vigilant, but we don’t think they’ll need to tinker with interest rates this year,” said Drummond. “Despite weak growth in late 2006, the Canadian economy is still around full capacity so we believe that monetary conditions are about right.”

The manufacturing sector will continue to experience job losses, but the economy as a whole will see job growth in 2007 little changed from its 2006 pace. “The unemployment rate will increase from 6.1 to 6.3% in 2007, but will remain near a generational low,” said Drummond.