Could Canada's Economic Growth Falter?

Some Canadians feel the economy will get worse in the next year despite all the evidence that it is bouncing back strongly from recession.

OTTAWA (CP) -- Canada's economy is on a tear, China's is exploding and even in the U.S. manufacturing is rebounding and jobs are poised for their first significant gain in two years. So why do Canadians feel so edgy?

According to a Royal Bank survey, two thirds of Canadians have been losing sleep over the state of their finances, and 22 percent were worried about losing their jobs.

More surprisingly, more Canadians -- 20 percent as opposed to 13 percent the previous month -- thought the economy will get worse in the next year despite all the evidence that it is bouncing back strongly from recession.

The sneaking suspicion that the rebound is mostly smoke and mirrors has some validity, say economists, who like many ordinary Canadians also believe the bubble is about to be burst.

"The nagging feeling that it's too good to be true, there's something to that," said CIBC economist Benjamin Tal.

Tal's consumer capability index suggests that the Canadian economy is running on steroids, namely government stimulus and record-low interest rates, and will start sputtering when the boost is removed. That's only a few months away, he says.

The index looks at seven indicators of personal finances and they point to the fact that debt-ridden Canadians are spending beyond their means and when interest rates start rising in a few months, they will suddenly realize it.

A pile of worries is mounting for Canadian consumers: income growth remains flat and the cost of mortgages, consumer loans and lines of credit are increasing as well. Food and energy costs continue to rise and now ordinary Canadians face a bigger tax bite as governments try to wipe out their deficits.

On Thursday, the public outrage over Quebec's tax-hiking budget spilled into the streets as thousands of demonstrators clogged Old Montreal's business district.

Chanting, placard-waving protesters marched on behalf of numerous causes to denounce a budget that polls suggest is exceptionally unpopular because it piles new costs on Quebecers, including a sales-tax hike and new health-care user fees.

That kind of backlash by ordinary Quebecers suggests Canadians are worried about their financial future in a growing, but still fragile, economy.

In an interview, outgoing Bank of Canada senior deputy governor Paul Jenkins advised against irrational exuberance about the glowing output numbers being put up by the Canadian economy. The five percent growth in the fourth quarter of 2009 was unexpected, and the 5.5 percent growth that many believe the economy put in over the first quarter of 2010 is even more eye-popping.

But in his 37 years at the central bank, Jenkins has seen it all and cautions that turning points in the economy, particularly when the government has primed the pump with $46-billion in stimulus and the central bank has taken overnight rates to practically zero, can result in some weird numbers.

"It's important to take a perspective that looks beyond one or two quarters," Jenkins cautioned. "You need to think about when that stimulus rolls out. What’s the economy going to look like."

Simply put, many Canadians may have been lured into spending on homes, cars, furniture and appliances before they otherwise would, which means they could be spending less in future.

That's just what the CIBC's Tal thinks has happened. He notes that over the last year, when in most months the economy was shrinking, household borrowing increased by seven percent -- more than three times that of incomes.

Given the red-hot housing market, it's not surprising that 70 percent of that has gone into mortgages as Canadians kept buying homes in the face of employment uncertainty. There's only one reason for that, says Tal -- mortgage rates were too good to pass up.

It could be that Canadians will keep on spending sufficiently to keep the economy afloat, says Toronto-area economist Dale Orr. Canadians haven't been as hard hit as their U.S. cousins and their house values haven't collapsed.

"Unlike most of the other counties, Canada's recession wasn't a financial market recession. Ours was an export recession," he noted.

Bank of Montreal economist Douglas Porter adds that a stronger-than-expected recovery in the U.S. will lift the Canadian economy even if consumers do slow spending.

But even Orr believes the economy will slow, and the Bank of Montreal's official forecast also calls for a more muted second half.

One significant brake, says Tal, will be government policy. Policy-makers were effective in backstopping the economy in rough times, and will be just as effective in applying the brakes when activity threatens to overheat.

"If you look at recoveries over the past 50 years, none of the recoveries were linear, and this will be the most non-linear of them all," noted Tal.

"There is so much artificial stimulus happening from the U.S. and Canada ... and the future is coming in the second half of the year when the government will be a negative for the economy."

Tal does not believe the reckoning will result in a double dip -- a true second recession -- but it will be enough to slow growth from the current five-per-cent clip to about two percent.

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