Canadian economy in decline, but 'sky not falling:' Bank of Canada

OTTAWA - The Bank of Canada offered its starkest outlook yet for the Canadian economy Thursday, placing the country on the precipice of a recession that will result in fewer jobs, reduced household wealth and falling house prices.

Still, bank governor Mark Carney said Canada is better off than most industrialized countries and that there is no cause to panic.

"The sky is not falling, the sky is still there, the sun is still coming up every single day and the Canadian economy is still functioning," he told a news conference Thursday after releasing the central bank's newest economic outlook.

The new forecast - a sharp downgrade from July - has the economy shrinking by 0.4 per cent annualized in the October-December quarter and at no growth in the first quarter of 2009 - just skirting the two consecutive negative quarters that is the technical definition of a recession.

But there is nothing technical about what is happening in the rest of the world in the face of the financial markets crisis. The world will soon be in a mild recession, the central bank says, and the United States - Canada's largest trading partner - has already stumbled into one.

Carney refused to use the R-word at his news conference, although he acknowledged this was "a difficult time" and that the bank's estimates could miss the mark. The central bank has already downgraded its forecast for growth four times this year.

Finance Minister Jim Flaherty summarized the bank's assessment as "near the line" of a recession, adding "I think that's fairly accurate."

But Bank of Nova Scotia economist Derek Holt believes both the finance minister and central bank governor are overly optimistic.

"I don't see that the U.S. is in recession right now and the global economy goes into a recession and yet Canada somehow is an island," he said. "That's just not credible in the current market and we continue to forecast a Canadian recession with a lot of downsides to go."

TD Bank chief economist Don Drummond said the state of the economy is far too fluid to put much faith in anybody's forecast.

"We're sitting here at a fork in the road and you don't know where we're going to go," he said.

"You have to admit that virtually every number that's come out, particularly from the United States, in the last month or two has been worse than anyone anticipated. It really seems to be sliding very quickly."

Where public officials and private sector economists agree is that the hard times hitting Canada emanate from abroad.

The collapse of financial institutions in the U.S. and Europe has sent shock waves around the globe with banks fearful of lending to each other, tightening credit conditions for businesses and consumers, which in turn has put the breaks on growth worldwide.

All this turmoil washes onto Canada's shores in the form of reduced demand for Canadian exports, and lower commodity prices for such things as oil, and most recently, a falling currency.

In addition, the restructuring of the North American auto industry has led to thousands of jobs cuts in Canada, dragging down an already battered manufacturing sector hurt by a recent high dollar, a slumping U.S. economy and troubles in the lumber-dependent U.S. housing market.

Carney said Canadians can expect one of the few remaining positive aspects of the economy - job growth - to turn south in the near future, although he would not predict actual job losses.

The jobless rate stands at 6.1 per cent and 107,000 jobs were created in Canada last month - but nine in 10 of them were part time and job growth could be negligible in the coming months.

Housing prices have already slowed down and will fall further, the central bank says, and household wealth will come under increasing pressure, restraining spending.

For the federal government, Flaherty said at a separate news conference that the government may have to back off on some of its spending commitments next year. Even so, Flaherty would not rule out the first federal budget deficit in a dozen years, something Ontario has said it will suffer this year.

Two private-sector economists predicted last week that Ottawa would face several years of deficits if Flaherty does not cut spending, with next year's budget shortfall hitting $10 billion.

"This is obviously a serious situation," Flaherty said.

"We have to review where we are in terms of various obligations and pressures in the next fiscal year, so I'll have more to say on that later."

Flaherty ruled out delaying scheduled business tax cuts, however, saying this is not the time to remove fiscal stimulus from the economy. And Carney said the bank may have to further cut interest rates - after slicing three-quarters of a point in the past two weeks - before the year is out.

The finance minister also announced a new measure to increase confidence in the Canadian banking system, saying deposit-taking institutions will be able to obtain a government guarantee on loans they may need to finance operations and extend credit to Canadians.

It could be worse. Canada could be the U.S., which has had to inject almost $1 trillion into the economy and its imploding financial sector, with more in the offing.

One reason Carney sees Canada not falling as far as other countries is that its fundamentals, including job growth, household wealth, housing and even the fiscal soundness of governments, are starting off from a higher position.

The other major factor is that Canada's banking system is the envy of the world and may actually be used as a model by other countries at future international meetings dealing with the crisis, said Carney.

"Unlike in a number of other countries, we have a financial system that is functioning," Carney said.

"We don't have a system we need to repair. Our system is sound; it is well capitalized."

The lower dollar is also helping the Canadian economy cope, he added, by making exports less expensive and giving domestic manufacturers a leg up on foreign imports.

Canada won't come out of the malaise until 2010 with a return to more normal global financial conditions, says Carney, when growth will rebound strongly to 3.4 per cent for the year.

Carney praised the aggressive rescue plans put into action around the world, including governments guaranteeing interbank lending and even directly injecting capital into the system by in essence buying shares in the banks and other lending institutions.

As well, central bankers, including Canada's, have lowered interest rates and worked in concert to inject cash into the system.

"The action plan in the right plan, it is being implemented, and it is going to work," he predicted.

The central bank's outlook also calls for the Canadian dollar to average 85 cents US and oil around US$82 a barrel over the next six months, above current levels of about 79 cents US and US$68 a barrel. On an annual basis, the bank expects Canadian growth to finish at an average 0.6 per cent for this year and next.