Canada’s economic growth will be lacklustre this year, reflecting sluggish consumer spending, cooling of the housing market and less government spending as stimulus programs end, according to an Investment Executive survey of nine economists in the financial services sector.

Most economists surveyed say growth in real gross domestic product will range from 1.7% to 2.6% this year. But one — Paul Ferley, assistant chief economist with Royal Bank of Canada in Toronto — forecasts a 3.2% increase in real GDP in Canada and 3.3% in the U.S., which also is higher than the predictions of 2.4%-3% for the U.S. by the other economists surveyed. Ferley thinks there’s more confidence and underlying momentum, both here and in the U.S., than other economists believe. Economic growth in the U.S. is an important determinant of Canada’s growth because we export so much to the U.S.

All of the economists surveyed are basing their predictions on the assumptions that current U.S. fiscal and monetary policies work; the European sovereign debt problems don’t provoke another credit crisis; emerging Asia manages to control rising inflation without slowing growth too much; and there aren’t currency and trade wars between China and the U.S.

Those are big assumptions. Yet the economists emphasize that there’s as much upside risk as downside because U.S. consumers are a resilient bunch and will get back shopping as soon as possible. The key is the unemployment rate. If there’s enough job growth to get the rate moving down consistently, retail cash registers will be ringing.

Here’s what the economists expect in the next two years:

> Growth. U.S. consumers are key for Canada as well as the U.S. The Canadian economy needs them to spend more so Canadian exporters can sell more. The U.S. needs them to spend to get its economy on a sustainable growth path. The recently announced extension of the tax cuts that had been introduced by former U.S. president George W. Bush should help. They are expected to add 0.5 to 1.0 percentage points to U.S. growth over the next two years; most economists surveyed say about half of that is likely to spill over into Canada.

Most of the economists are relatively happy about Canada’s prospects. The rate of growth in Canada may trail the U.S. growth rate because interest rates, already higher in Canada than south of the border, are likely to rise sooner. Also, the fiscal restraint needed to pay off the debt associated with the big government stimulus packages will start biting in Canada this year and next, but the impact of similar restraint probably won’t be felt in the U.S. until 2013.@page_break@However, there’s one dissenter. Lloyd Atkinson, financial and economic consultant in Toronto, suggests that much more fiscal restraint will be required in Canada than most economists think. In his view, total Canadian government debt — federal, provincial and municipal — is much higher on a relative basis than in the U.S., where most states and municipalities aren’t allowed to run deficits. He also expects less buoyant resources prices, another important determinant of Canadian growth. His oil price forecast is well below those of the others, especially in 2012. (See accompanying table.)

> Credit Conditions. Canadian banks didn’t experience many restrictions in lending in the wake of the recent credit crisis because they were in good shape; indeed, lending continued to increase. But in the U.S., there were huge cutbacks. Conditions there are improving — but slowly. It’s still hard for small U.S. businesses, which usually create most of the jobs in a recovery period, to get loans.

> Inflation. There’s little risk of inflation getting out of control in Canada, given soft domestic demand, persistent high unemployment and the Bank of Canada’s commitment to — and track record of — keeping it in the 1%-3% target range.

There’s even less danger in the U.S., where there’s much more excess capacity. Indeed, the risk in the U.S. is deflation, but economists believe that the U.S. Federal Reserve Board will do everything it can to avoid deflation — even if it means risking rising inflation in the medium term. The Fed’s quantitative easing — the purchase of Treasury bonds from financial services institutions — is aimed at reflating assets by putting more and more liquidity into the system so prices get bid up.

> Interest Rates. The Bank of Canada is expected to start raising interest rates slowly in the second half of this year, so there shouldn’t be a sudden and large impact on consumers’ debt-servicing costs. The timing and extent of increases depend partly on the U.S. If Canada’s rates get a lot higher than U.S. rates, that will fuel increases in the already high Canadian dollar, making it even more difficult for Canadian manufacturers who sell in the U.S. to compete there.

The Fed is not expected to start raising rates until late this year or early in 2012, and the increases will be small and gradual. The average forecast for 91-day T-bills in the U.S. is 0.3% for the end of this year and 1.5% 12 months later. That’s still a long way from a neutral — non-stimulative, non-restrictive — 4% territory. Only two economists surveyed see Canada’s rate around neutral by the end of 2012.

> The Canadian Dollar. Most economists surveyed expect the C$ to trade around parity with the U.S. dollar over the next two years, although there is likely to be volatility. The strength comes from continued high resources prices and a general downward trend in the US$; a lower US$ would make U.S. goods more competitive at home against imports, particularly from Asia, and in export markets.

However, two factors could have a big impact on currencies. The first is investor flight to safety, which means moving into US$ whenever uncertainty spooks investors. The second is the European sovereign debt situation, which could spur investors to abandon euros if that crisis worsens. IE