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As forecasts weaken, challenges mount at Bank of Canada

A hike in interest rates would put upward pressure on the Canadian dollar and on manufacturers. Here, a worker assembles a Bombardier Global business jet at a plant in Toronto.

MICHELLE SIU/THE CANADIAN PRESS

The Canadian economy is gearing down as a faltering housing market, tepid consumer spending and choppy demand for exports turn a slow-growing economy into a barely growing one.

Economists from Bay Street to Ottawa and Paris have downgraded their growth forecasts in the past month, and some see the tepid climate stretching well into next year.

A number of indicators are pointing to a sharp slowdown in economic growth, among them weaker housing activity, softer retail sales and deteriorating demand for exports.

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Over the next year, slow growth won't be enough to substantially budge Canada's jobless rate, now at 7.4 per cent. It also reduces the odds of rate hikes in the first half of next year – regardless of who succeeds Mark Carney as the next Bank of Canada governor.

Friday's GDP report is expected to show third-quarter economic growth of less than 1 per cent annualized – a consensus that itself has softened in the past week – the weakest pace of expansion since the second quarter of last year and a clear deceleration from 1.8-per-cent growth in the prior quarter.

"The data suggest that it's in for a bit of a rough patch," said Bricklin Dwyer, economist at BNP Paribas in New York.

The Organization for Economic Co-operation and Development became the latest to cut its outlook for Canada Tuesday, chopping its growth forecast for next year to 1.8 per cent from its prior peg of 2.6 per cent. Its views on employment, too, have shifted, with the organization now seeing the jobless rate sticking above 7 per cent through next year.

"Economic growth has softened as the year has wore on and is likely to remain only moderate until mid-2013," the Paris-based organization said.

It cites a range of challenges, from cooling housing investment and house prices to overextended households, a shrinking public sector and exports that are hampered by poor competitiveness and weak global growth.

Royal Bank of Canada strategists are anticipating a "material" slowdown in the third quarter in a report that paints a picture of a "decelerating economy," while National Bank Financial senior economist Krishen Rangasamy says the headwinds that Canada currently faces "are not going away just yet."

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Record high debt loads will continue to restrain household spending, he says, while a recession in Europe, and possibly Japan, bodes ill for Canada's exports. Businesses, meantime, "will continue to be faced with a challenging environment going forward," notes Toronto-Dominion Bank economy Dina Ignjatovic, as high debt levels dampen domestic demand just as uncertainty about the global economy and the U.S. fiscal cliff weigh on exporters.

The Bank of Canada's new governor will have to weigh duelling challenges. Higher rates next year would help stem the borrowing frenzy that has sent house prices soaring in recent years. But any interest rate hike – at a time when the U.S. Federal Reserve is firmly on hold – would also propel the Canadian currency to new heights, which puts more pressure on Canadian manufacturers (the country's third-largest employer by sector).

It could be the next interest rate moves are no move at all. Bank of Nova Scotia economists Derek Holt and Dov Zigler think the central bank will stay on hold through to 2014, "with the bigger risk being later rather than sooner as housing comes off the boil and the trade picture remains under pressure." The OECD, for its part, thinks rate hikes "may be needed" by the second half of next year to address imbalances in the housing market.

The shift comes as the economic outlooks for Canada and its next-door neighbour begin to favour the United States. Consumer confidence, for example, is running at its highest level since 2008 in the U.S., while in Canada it has fallen for the second month in a row.

The picture should brighten – a little – in the coming quarters. BNP's Mr. Dwyer see Canadian growth picking up to the 2-per-cent mark next year, and is paying particular attention to measures on the health of the housing market, household debt and changes in wages to gauge the outlook for the economy.

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About the Author

Tavia Grant has worked at The Globe and Mail since early 2005, covering topics from employment and currency markets to trade, microfinance and Latin American economies. She previously worked for Bloomberg News in Toronto and Zurich, writing on mining, stocks, currencies and secret Swiss bank accounts. More

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