Canada?s economy to pick up speed, but headwinds remain: IMF

The Canadian economy is expected to pick up speed ? a little ? by the middle of next year, though external risks still ?loom large,? a new forecast said Wednesday.

The country?s gross domestic product will grow 1.8 per cent next year and accelerate to 2.25 per cent in 2014, the International Monetary Fund said in its preliminary assessment of the Canadian economy. That?s down slightly from its October forecast of 2 per cent growth for next year.

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But headwinds remain. Among them are uncertainties over the impact of the U.S. ?fiscal cliff,? a worsening euro-area debt crisis and a projected slowdown in consumption and housing amid record household debt levels.

The economy slowed this year, and a still-soft performance in 2013 means interest rates should increase ? only gradually ? starting late next year once activity revs up.

?Downside risks from external headwinds continue to loom large,? it said. ?The impact of these shocks on the Canadian economy would be exacerbated by the elevated level of household debt.?

Household debt-to-income ratios remain high in relation to assets. At the same time, the fund?s analysis show levels of real house prices and residential investment remain ?above levels consistent with economic fundamentals.?

While Canada is unlikely to suffer from ?a house boom-and-bust episode? similar to that of the United States, the unwinding of household financial imbalances ?could prove more disruptive than anticipated in our baseline scenario, especially if household leverage were to keep rising.?

The federal government has already tightened mortgage lending standards, a move that was ?appropriate,? said Roberto Cardarelli, IMF mission chief to Canada, at a press conference. Its models show these steps have been effective in preventing ?even greater exuberance? in the housing sector.

But should household debt levels continue to rise ? and many economists believe they will albeit at a slower pace ? ?additional measures may be needed,? the IMF said. Some options include requiring higher down payments for first-time buyers and lowering caps on debt-service-to-income ratios.

House prices are currently about 10 per cent overvalued, said Mr. Cardarelli. It too sees a cooling in the housing market, with residential investment and house prices expected to fall ?gradually to more sustainable levels.?

As for external risks, sharp fiscal consolidation in the U.S. would heighten challenges for the Canadian economy. IMF analysts figure the impact on Canada from the ?fiscal cliff? would be about three quarters of the effect on the U.S. economy. A worsening euro-area crisis could hit Canada through tighter financial conditions and waning confidence. And weaker global demand would slam Canadian exports and dent commodity prices.

Balancing the federal budget by 2015 is ?within reach? however some provinces may need to step up efforts if they are to balance their books.

In the event of a big shock to the economy, the federal government should consider new temporary fiscal stimulus measures, the fund said. And the Bank of Canada would have room to cut interest rates.

The Canadian currency is between 5 per cent and 15 per cent overvalued, meaning it is trading higher than what economic fundamentals would suggest relative to other currencies.

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Source: http://www.theglobeandmail.com/report-on-business/economy/canadas-economy-to-pick-up-speed-but-headwinds-remain-imf/article6553634/?cmpid=rss1

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