04/09/2013 03:46 EDT | Updated 06/10/2013 05:12 EDT

Economic Forecast Canada: Housing Bust To Push Unemployment Up, Capital Economics Says

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OTTAWA - A leading international forecasting firm says Canadians should brace for tough economic times lasting another two years, lifting the jobless rate once again beyond eight per cent and setting back Ottawa's plans to balance the budget.

In one of the gloomiest forecasts issued on the Canadian economy since the recession, Capital Economics predicts a sharp and protracted housing correction, in conjunction with muted business investment and government austerity, will keep Canada's economy in stall mode throughout 2013 with a one per cent growth rate, only improving slightly to 1.3 per cent in 2014.

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That's half the current Bank of Canada estimate on both years, and well below the 1.6 per cent consensus used by Finance Minister Jim Flaherty in the March budget for the current year.

"Canada's economy has lost considerable momentum and signs unfortunately point to continued slow growth ahead," says the new outlook.

"With the housing downturn intensifying, business investment intentions softening and government plans to restrain spending, we expect GDP (gross domestic product) growth of only one per cent in 2013 and 1.3 per cent in 2014."

In an interview, the firm's chief Canadian economist David Madani agreed that his view is darker than most, but noted the consensus — the average of forecasts — has been steadily dropping for months and coming closer to his position.

And recent indicators all point to weak growth, he added. Job creation for the first three months of the year has been non-existent. In fact, there has been a net loss of about 26,000 jobs, while exports remain weak.

On Tuesday, the Canada Mortgage and Housing Corp. reported housing starts inched up to 184,028 annualized in March from the previous month, but were still 13.6 per cent below a year ago. As well, Statistics Canada said February building permits for residential construction fell 7.2 per cent.

Madani said where he differs from many other economists is that he believes Canadians are in for a rough ride in the housing market, one of the pillars of economic growth until recently.

"I wouldn't be surprised to see housing starts fall to 150,000 by the end of the year," he said. "Historically housing markets are either overbuilding or underbuilding and this boom we've been in the last decade has been enormous ... and that why I think the correction process will be fairly severe and protracted."

Over the long term, Madani says Canadian home prices, which have held up remarkably so far in the face of falling sales and starts, will drop by 25 per cent.

The only bright spot in the outlook is exports, said Madani, which will benefit from the recovery in the United States, particularly in the auto sector and housing market that support shipments of Canadian lumber.

But given the size of the Canadian housing market, and weakness elsewhere, Capital Economics sees only minimal employment growth in the next two years, in the range of 11,000 jobs a month. That won't be enough to absorb population growth causing the unemployment rate to rise from the current 7.2 per cent to 8.1 per cent by the end of 2014.

With the economy underperforming, and low inflation, government revenue growth will also suffer, the firm says.

The Harper government has staked political capital on eliminating the deficit in 2015 so it can fulfil several campaign promises to bring in partial income splitting and doubling tax-free savings account limits in time for the next election.

"Unfortunately, eliminating deficits will take much longer than federal and provincial governments currently expect, even if the focus remains on controlling spending," the report states.

Fortunately, Madani said most Canadian governments have sufficient fiscal room to be able to quickly transition to stimulus spending if the economy performs even worse than he expects.

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