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Consumers looks for a deal (Deborah Baic/The Globe and Mail)
Consumers looks for a deal (Deborah Baic/The Globe and Mail)

Canada's economic bounce will be short-lived, Merrill Lynch says Add to ...

The new chief economist for Merrill Lynch Canada has finally landed and published a forecast that is significantly more optimistic about the Canadian economy in the short run, but less enthusiastic for next year.

Sheryl King, who was a senior U.S. economist for the firm but moved to Toronto last week, believes the Canadian economy has begun to grow and will pick up strength throughout the rest of the year.

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But she also projects that the Bank of Canada will get carried away with the surge in growth, scale back its economy-fuelling measures too fast, and undermine the recovery.

"It will choke off growth," Ms. King said in an interview. "The upturn in the economy will be very short-lived indeed."

Ms. King sees a 1.8 per cent contraction of the Canadian economy in the second quarter, at annualized rates, but a 1.3 per cent expansion in the third quarter, and a 3.8 per cent pace in the fourth quarter.

The bounce tapers off quickly, however, and she sees the Canadian economy barely moving by the end of 2010, at a 1.5 per cent annual pace.

Overall, she forecasts a 2 per cent decline in output in 2009, followed by a 2.7 per cent expansion in 2010, with monetary policy being the key driver of how the Canadian recovery takes shape.

The previous Merrill Lynch Canada forecast, authored by David Wolf who has moved to the Bank of Canada, projected a 2.7 per cent contraction in 2009 and a 2.3 per cent rebound next year.

"All of it will depend on how well policy is steered," Ms. King said, explaining why she made the changes.

The Bank of Canada "overreacted" to the global financial crisis by taking interest rates too low and making credit too easy, she argued. And as the Canadian and global economies begin to recover, the central bank will likely overdo it again, and withdraw its support too fast.

The key mistake by the Bank of Canada was assuming that the credit crunch that has plagued the U.S. economy exists here as well, she said. But in Canada, low interest rates are very effective, fuelling the housing market, real estate, business investment and consumers' buying intentions.

"We're seeing a lot of interest-rate response that's percolating beneath the surface."

If commercial banks aren't lending, it's because they are acting prudently in the face of a "plain, old-fashioned recession" and not because they're strapped for cash.

Once the central bank sees the pick-up in growth, it will get nervous about its commitment to keep interest rates low for a long time - a nervousness that will likely drive up long-term interest rates, she said.

Lending conditions will probably start to tighten, but the Canadian recovery and global growth will still be too fragile to resume robust growth without the support of the central bank, she argued.

"This is not really a bullish scenario," she said. Policy makers "are trying to get in front of a huge freight train, and they're throwing all that they can in front of it. And to some extent, they're going to be successful. But ultimately, there are still underlying problems, especially in the global economy."

Ms. King's U.S. counterparts at Banc of America Securities/Merrill Lynch have recently revised up their forecast for the U.S. economy as well. They now expect a 2.1 per cent contraction followed by a 2.6 per cent expansion next year, instead of a 2.4 per cent contraction followed by a 1.8 per cent expansion.

But much of that growth comes from fiscal and monetary stimulus aimed at the domestic economy, and probably won't help Canada much, Ms. King said.

Still, it's not all bad news for Canada. The unemployment rate will probably peak in the next few months at below nine per cent, she projected, and then slowly edge back down to just above eight per cent by next year.

 

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