The dominant economic theme for 2008 will be significantly slower economic growth in the United States, Canada and around the globe, according to the December issue of the TD Quarterly Economic Forecast.
In the U.S., the fallout from the problems in credit markets, which intensified once again in November, will aggravate the weakness in real estate markets. High inventories of unsold homes and weak demand for real estate are likely to lead to a 5 percent decline in U.S. existing home prices in 2008.
The negative wealth effects from housing and the likelihood of tighter credit conditions will dampen consumer spending in a significant way. "This has led us to scale back our expectations for U.S. economic growth by more than half a percentage point to a modest 1.8 percent in 2008," remarked Alexander.
Given this backdrop, the Federal Reserve is expected to cut rates by a further 50 basis points in early 2008. While this will make monetary policy more stimulative, TD Economics warn that a lower fed funds rate will not resolve the strains in the financial system and it will only help to temper the coming slowdown in consumer spending and the weakness in real estate.
TD Economics is convinced that the credit and housing problems will be resolved with time, and that is why economic conditions are forecast to improve in the second half of 2008 and economic growth is expected to rebound to 2.8 percent in 2009.
The correlation between overseas economic growth and U.S. consumer activity remains strong. This implies that the coming tightening in American purse strings will act as a major dampening factor on many economies, particularly in Japan and the newly industrialized Asian economies. Meanwhile, Europe is being hit by the fallout from the credit crunch and exports from the region are likely to soften in the coming quarters. As a result, TD Economics is forecasting that world economic growth will drop by a full percentage point from 5.2 percent in 2007 to 4.2 percent in 2008.
Canada will be buffeted by these trends. Exports will be dampened by softer demand in the U.S. and overseas. Manufacturing will also struggle with a Canadian dollar that will average 97 U.S. cents in 2008 and average 92 U.S. cents in 2009. Slower inventory accumulation will also constrain economic growth over the next couple of quarters. Finally, the fallout from the on-going abnormal state of money markets in Canada will also have a modest adverse impact on the economy, but the consequences are expected to be significantly less than in the U.S. and Europe. Canadian housing markets are projected to cool in the coming year, with housing starts edging down from an average of 230,000 in 2007 to 210,000 in 2008 and resale home prices are expected to advance by a more moderate 6.3 percent in the coming year.
Finally, Canada cannot count on rising commodity prices to provide an offset, as slowing global economic growth will lead to a modest pullback in raw material prices. As a result, while domestic demand will remain solid, Canadian economic growth will not be terribly different than that in the U.S. in 2008, with Canadian real GDP advancing by 1.9 percent, before picking up to 2.5 percent in 2009.
The prospects for weaker economic conditions is expected to lead the Bank of Canada to cut rates by a further quarter point on January 22nd, but the monetary authority will likely leave rates on hold thereafter. Although economic growth will prove modest over the next few quarters and inflation will dip to well below 2 percent in mid-2008, very little economic slack will develop, as best illustrated by the expectation that the national unemployment rate will hover near 6 percent, and inflation will quickly return to the Bank's 2 percent target in early 2009.
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