Canada may be losing its immunity to the global slowdown/recession, but, most economists say, Canadians are not likely to suffer to the same extent as Americans.

Unemployment in Canada probably won’t climb as high as in the U.S. And Canada has not seen the destruction of wealth wrought by plunging house prices that has occurred south of the border. Credit is still available in Canada as banks continue to lend, albeit at somewhat higher interest rates than previously. (See story, left.)

Government finances are also in much better shape in Canada than in the other big industrialized countries, providing Ottawa with the fiscal wiggle room to stimulate the economy with government spending and/or tax cuts. Prime Minister Stephen Harper’s government has promised a stimulus package will be in its Jan. 27 budget, and economists’ estimate the price-tag will range from $8 billion-$10 billion to as high as $30 billion over two years.

The big hit to the Canadian economy is coming from shrinking exports; 80% of our exports, which account for about 40% of gross domestic product, go to the U.S. So, the deeper the U.S. downturn, the more Canada will feel the effects. Domestic demand is still growing in Canada, however, if slowly.

In the U.S., domestic demand has dropped, making the pain on Main Street much worse. President-elect Barack Obama has promised a huge fiscal stimulus package to take effect as soon as he takes office this month. Analysts say Obama will have no trouble getting the package through Congress and the Senate. At the same time, the U.S. Federal Reserve Board has committed to buying US$100 billion in mortgages, mainly from government-sponsored Freddie Mac and Fannie Mae, in an effort to get mortgage rates moving downward. The Fed is also prepared to buy U.S. treasuries to increase liquidity in the financial system.

These measures, combined with similar actions around the world, are expected to resolve the global credit crisis and get global banks lending again — the key ingredient for a return to healthy economic growth.

The big risk is if these measures don’t succeed. “The trigger could be the inability to stabilize U.S. house prices,” says Carlos Leitao, chief economist at Laurentian Bank Securities in Montreal. That could produce a much “nastier” recession in the U.S., which would drag everyone down, including Canada.

One concern for Canada, particularly if the U.S. economy continues to contract, is that Washington will demand that the car companies repatriate auto jobs as part of the price for government bailouts. “Hopefully, Ottawa can work with Washington to prevent this,” says George Vasic, chief economist and equity strategist at Toronto-based UBS Securities Canada Ltd. “If the government fails to do so, it will be another negative facing the Canadian economy — and the Ontario economy, in particular.”

But economists believe that even if there’s a delay in kick-starting the global economy, governments and central banks are so committed to getting out of the current situation that they won’t stop their efforts until the global economy shows signs of recovery. Canada is unlikely to see a repeat of the Great Depression of the 1930s, when real GDP fell by 50%, they say, but we could see a drop in GDP of 10%, which would be painful enough.

The general view among economists is that growth will resume in the second half of 2009 but at a slower pace than the 4%-6% typical of the aftermaths of most recessions. Instead, economists see growth in Canada and the U.S. returning to 2.5%-3% in the second half, a healthy but not buoyant pace. That means unemployment will take longer to come down, interest rates will move upward more slowly and corporate profits will increase only moderately. But even if the U.S. and Canadian economies resume growth in the second half of 2009, that still translates into a drop in real GDP for the year as a whole.

Only one of the nine economists surveyed for this year’s report by Investment Executive thinks Canadian real GDP will increase in 2009 (see table); all nine expect a decline in U.S. GDP. For 2010, the average forecast is 1.9% GDP growth in Canada and 2.2% in the U.S.

Leading the pessimists are Beata Caranci, director of forecasting with Toronto-basedToronto-Dominion Bank’s economics department, and Lloyd Atkinson, a Toronto-based economic and financial consultant. Caranci expects 2009 GDP to decline by 1.4% in Canada and 2% in the U.S.; Atkinson is calling for a 1.8% decline in Canada and 2.3% in the U.S.

@page_break@U.S. consumer confidence won’t recover until there’s a big fiscal stimulus package, says Atkinson, that stops the job losses and income erosion. Even if the package takes effect early in 2009, people will wait to see the impact before they open their pocketbooks. That means more job losses and bankruptcies in the first half of the year, with a big spillover effect for Canadian exports.

Caranci has become more pessimistic as signs of improvement in financial markets — particularly, the cost of funding for banks — have failed to materialize and erosion in global financial activity has been more pervasive than expected. Caranci has much the highest forecast for Canada’s 2009 current account deficit, at $55 billion.

Atkinson and Caranci both expect Canadian unemployment to jump dramatically, averaging about 8% in 2009 and 2010, vs about 6% in 2008. They note, however, that this will still be lower than the U.S. jobless rate, which Atkinson says will be about 9%.

Most of the other economists expect the Canadian jobless rate to be about 7% in 2009 and 7%-7.7% in 2010. Unemployment is a lagging indicator; it usually continues to climb after an economic recovery begins because companies don’t start hiring until demand is strong.

Short-term interest rates may already have bottomed; if not, they are expected to do so in the first half of 2009. The question is how quickly they will increase. Most of those surveyed think rates will remain low throughout the year, then move gradually upward.

Atkinson expects 91-day T-bills to be at 0.6% by the end of 2009. That reflects deflation fears as well as drops in the federal lending rate aimed at stimulating the economy. In his scenario, the deflation concerns will be fed by drops of 0.1% in the Canadian consumer price index and 0.4% in the U.S. CPI.

Atkinson doesn’t think deflation fears will be realized, however. In 2010, he expects 2.2% inflation in Canada and 2.7% in the U.S.

Although none of the other economists expect a drop in inflation, most don’t see much upward price pressure materializing in 2009 or 2010. That allows the Fed and the Bank of Canada to keep interest rates lower for longer than is normal once the recovery starts. The situation is that the global slowdown/recession is leaving companies with no pricing power and the big drop in oil prices is reducing gasoline and heating costs. The average forecast for the rise in the CPI is still less than 2% for both Canada and the U.S. in 2010.

But inflation is not dead and, indeed, could come back quickly. The central banks have been injecting enormous amounts of liquidity into the monetary system; if they don’t mop it up quickly once the economic recovery arrives, inflation could rear its ugly head. This could happen in 2010 if the Canadian and U.S. stimulus packages work better than expected.

Once there are signs that the economic recovery is underway, economists expect long interest rates to move up again, but they differ on the timing and speed. Forecasts for the rate on 10-year Canada bonds range from 3.1% to 4% for 2009 and from 3.5% to 4.2% for 2010.

Many economists believe oil prices won’t fall much further, although they admit US$30 a barrel or less is not impossible. But once the economy begins to recover, oil prices will probably start climbing. Forecasts for average oil prices range from US$67 to US$80 a barrel in 2010. Atkinson is an exception, expecting an average oil price of about US$50 in 2010.

Usually, the Canadian dollar moves in tandem with oil prices, but that has become complicated in these uncertain times by the fact that the U.S. dollar is considered a safe haven. So, some economists see the C$ at about US80¢ or even lower at the end of 2010, while others expect it to move up to US87¢ or even above US90¢. IE