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2012 Outlook for Canada's Economy? Not Too Shabby.

Posted: 01/ 6/2012 2:34 pm

Now that the holiday parties have wound down and everyone is settling back into their normal routines, let's take a look at the year ahead for Canada. While many will be more than happy to close the books on 2011, simply flipping the calendar over to a new year does not magically make all the problems of the previous year disappear. If anything, the outlook for 2012 suggests the new year will present an even greater challenge due largely to the escalating problems in Europe and the impact this is expected to have on other markets.

From a global perspective, 2011 was punctuated by the Eurozone debt crisis. Indeed, the situation deteriorated considerably during the second half of the year and few analysts see an improvement in the short term.

Bear in mind that in today's world, no economy is completely in isolation and a cataclysmic event in one jurisdiction will have an impact -- at least to some degree -- upon other economies as well. With the continuance of the current state of affairs in Europe, there is concern that other markets -- including Canada -- will suffer from the spill-over effect as the Eurozone struggles to contain debt contagion from spreading further within the region.

As 2012 gets under way, the threat of a sovereign default in the Eurozone is at an all-time high. A debt default and possible loss of one or more Eurozone members will make market losses to date seem minor by comparison. For Canada, a weaker European economy will score a direct hit on export sales. Much of Canada's wealth comes from the sale of its exports to other countries with resources and manufacturing being the two most important sectors. In 2010, Canadian exports totaled nearly $400 billion with about $27 billion going to the Eurozone countries.

While EU sales may account for less than seven per cent of total exports, the dollar amounts are still significant, and at a time when sales to other countries could also be depressed, Canadian manufacturers are right to be concerned.

2011 -- The Year that Was

Mid-way through 2011, the Canadian economy was expanding at a pace greater than the Bank of Canada's two per cent annual growth target rate. In response, Governor Mark Carney made several comments suggesting that access to inexpensive credit was the culprit contributing not only to an over-heated economy, but also to high personal debt loads which Carney referred to as the single greatest threat to the domestic economy.

With these remarks, the Governor was clearly setting the stage for an interest rate increase; however, as the year progressed growth slowed, making the need to adjust rates less critical. Gross Domestic Product (GDP) for the month of October was essentially unchanged from the previous month and with the European predicament taking a toll on the worldwide economy, central banks further lowered expectations for 2012.

The Bank of Canada, for instance, reduced its 2012 annual growth projection from 2.6 per cent to 1.9 per cent during the final quarter of 2011. The adjusted outlook places growth just under the upper target limit suggesting the Bank of Canada expects inflation to remain sufficiently contained for the new year thus negating the need for an immediate interest rate increase. Of course, should prices expand at too rapid a pace, the Bank has the option to raise rates later in the year.

For now, the Canadian economy appears reasonably well-positioned for the new year. While growth will not be spectacular, the economy is still expected to continue expanding and this should be supportive of the Canadian dollar. Commodity prices, especially oil, are expected to maintain and even increase beyond current levels and this should also be supportive of the loonie.

However, it could well be the American dollar that garners the most attention in the coming months. Mounting market uncertainty could force investors -- in the short-term at least -- to place a greater emphasis on wealth preservation rather than wealth creation, and this could have investors turning to the American dollar.

Despite the obvious problems of weak growth and stubbornly-high unemployment, the American economy remains the destination of choice when investors seek a "safe harbour" in which to ride-out market upheavals. The resulting increase in demand for the greenback could lead to an appreciation of the American dollar during the first part of 2012.