09/12/2011 05:07 EDT | Updated 11/12/2011 05:12 EST

Economy much weaker than expected, say banks, but Flaherty stays course for now

OTTAWA - Canadian forecasts are dramatically paring back expectations for the economy and jobs in the face of growing uncertainty about whether the global financial system is headed toward a new crisis.

The Toronto-Dominion Bank is the latest to downgrade its forecast, trimming its Canadian growth estimate by half a point to 2.2 per cent this year and 1.9 per cent in 2012, according to TD's chief economist.

TD's new estimate, to be released Tuesday, is even more pessimistic than Royal Bank's latest revision.

RBC said Monday it now estimates Canada's economy will advance only 2.4 per cent this year and 2.5 per cent this year. The new 2011 estimate is 0.8 percentage points off its previous projection.

And neither bank is ruling out a double-dip recession, especially after Canada suffered through an unexpected reversal in the second quarter, when national output contracted by 0.4 per cent.

"The recovery we see is uneven, uncertain and underwhelming. Any further shock to the system is enough to turn a small positive to a small negative," warned RBC chief economist Craig Wright.

TD Bank's chief economist, Craig Alexander, says any forecast now must be taken with a grain of salt, and the reality could turn out to be worse than even the new projections.

"The crystal balls are cracked and cloudy at the moment," Alexander said. "There's an unbelievable amount of uncertainty because the biggest risks all lie in the political arena. It's not clear whether the European political leaders can get the fiscal crisis under control."

Equally, it's impossible to predict whether the Democratic White House and Republic Congress in Washington can agree on economic policy, Alexander said.

In remarks to the Chamber of Commerce for Whitby, Ont., Finance Minister Jim Flaherty acknowledged Canada will at best realize modest growth in the upcoming months, but added the situation had not yet deteriorated to the point where he would consider a new round of stimulus.

"On the basis of where we are now, we will maintain our fiscal plan," he told reporters after his speech.

"Of course, we live in the real world," he added. "If there were to be an external shock that shook the Canadian economy, of course we would act in a pragmatic, flexible way."

According to the Liberal finance critic, however, the situation already warrants a reversal in the Flaherty's plan to cut $4 billion from government operations, much of it through staff reductions.

Liberal MP John McCallum urged Ottawa to put the plan on the back burner for up to 18 months.

"It's almost impossible to overstate the gravity of the situation in Europe," McCallum said. "Now is not the time to make cuts. You look around the world, you look in the U.S. as well and particularly in Europe, the situation is far, far worse than it was just a few weeks ago."

Many believe Greece will have little choice but default on its ballooning debt, which could trigger a second global banking crisis.

Alexander said if the crisis worsens in Europe, the ensuing loss of confidence in the financial system is likely to dampen consumer and business spending as well.

"There's enormous risks here and there's not much evidence how it will play out," Alexander said.

In terms of jobs, both RBC and TD see Canada's unemployment rate edging up toward 7.5 per cent by year's end after dropping as low as 7.2 per cent this summer. Last week, Statistics Canada reported the economy shed jobs in August for only the second month this year, pushing the unemployment rate to 7.3 per cent.

The slower growth profile also has the potential to throw off Ottawa's plans to eliminate the deficit in four years, although Flaherty insisted the budget is on track at the moment.

The wild card in trying to predict with confidence what will happen in Canada is that all the problems — and possible policy responses — originate beyond Canada's borders, specifically Europe and the U.S.

TD says the European economy is on its knees and may only grow by 0.9 per cent next year. The U.S. won't do much better with a 1.7 per cent gain, following this year's snail-paced 1.5 per cent advance.

Europe's crisis is affecting financial markets, but the U.S. is taking its toll on the real economy in Canada, particularly on exporters who ship about 70 per cent of goods south.

After being hopeful that this year would see a big turnaround in the export performance, Export Development Canada says it too will likely to tamper down its enthusiasm when it issues its next forecast in November.

In May, the EDC thought exports would jump 12 per cent this year, but that looks unattainable now, says the Crown company's Peter Hall, due to both temporary shocks in the Middle East and Japan, as well as the current emerging crises.

The one hope, Hall said, is that as Japan recovers and oil prices moderate, exports will see a temporary surge in the latter half of this year.

RBC's Wright also stressed that it is too early to panic. While another recession cannot be ruled out, the most likely scenario remains no worse than modest growth.

Wright sees potential in the large sums of cash corporations both in Canada and the U.S. have on reserve ready to invest.

Flaherty is thinking along the same lines. He urged firms "to step up to the plate" and make investments and create jobs, just as governments did in wake of the recession.

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