The struggle with the financial crisis and recession is not even over, and a new enemy is materializing: Inflation!

Desjardins Group economists forecast a new struggle against inflation

Lévis (Québec), June 26, 2008 – Canada could go into a recession and Ontario is already there, but Québec should be able to avoid slipping into one.

After four straight months of pullbacks, the Canadian economy is at risk, vulnerable to an official recession. This year, it will record a meagre 1% growth, gaining more strength in 2009, at 1.8%. With a high dollar, stagnant American economy and stronger international competition, foreign trade is the Canadian economy’s Achilles’ heel, especially in central-eastern provinces such as Ontario and Québec.

That’s what emerges from the latest forecasts by Desjardins Group economists, released today.

Highly dependent on trade with the United States, Ontario is being hurt due to its overexposure to the structural and economic problems facing U.S. automakers. “It now seems clear that Ontario is going through a recession, though only a slight one. Economic growth is expected to reach just 0.5% in 2008, only regaining some steam in 2009, at 1.3%,” stated Mr. François Dupuis, Desjardins Group Vice-President and Chief Economist.

In Québec, Desjardins’ economists believe, the tax relief and investment in infrastructure came at the right time to support growth. Québec’s GDP will match Canada’s pace in 2008, and be just below it in 2009, at 1.7%. “The Canadian aerospace industry’s large concentration in Québec is an asset. To stave off a recession, consumers will have to stand fast, despite the bite being taken by skyrocketing gas prices,” asserts Mr. Yves St-Maurice, Director and Deputy Chief Economist at Desjardins Group.

Growth jeopardized by inflation

The talk is more focused on oil prices, especially in the United States, where the rise in gas prices has been magnified by the soft dollar. The impact is so substantial that a large portion of the tax rebates issued under the economic stimulus plan could be eaten up to help deal with the increase in energy prices. Forecast real GDP growth for 2008 is 1.2%, but the outlook has been lowered from 1.9% to 1.3% for next year. According to Desjardins’ economists, it will take longer for the housing market to get back to equilibrium, while consumer confidence, now at a historic low, will remain fragile.

Globally, the economy will feel the effects of the American slowdown, tightening credit conditions, drop in consumer confidence and increase in prices for oil and foodstuffs. Following global real GDP growth of nearly 5% in 2007, growth is expected to plummet to 3.7% in 2008 and 2009.

An end to rate cuts

While noting that the global financial crisis has left its mark, Desjardins’ economists believe that the situation is now calmer. But just when a period of respite seemed to be emerging, inflation is rearing its head again, looming over monetary authorities. Another battle is in the works.

Given the fear of seeing inflation become entrenched in the economy and the risk that inflation expectations could go off on a lasting upward tangent, at central banks, the overall order of the day is to not pour oil on the fire by lowering interest rates. “This confirms that price stability is the central banks number one priority,” says Mr. St-Maurice.

For now, the central banks think that prevention is the best possible action. Over the next few months, a status quo appears to be more likely than rate hikes, as sometimes rumoured. The European Central Bank (ECB) will be the exception, instituting a single 25 basis point increase in July.

For its part, the Bank of Canada decided to fall in with the trend on June 10 when, to general surprise, it kept its key rate at 3.0%. Desjardins’ economists believe the monetary policy status quo should extend through 2008, keeping mortgage rates very close to where they are now. Oil should fall back below US$100/barrel

As for oil, the bubble could burst without warning, but a more likely scenario is a gradual return toward crude prices that are founded on the theory of supply and demand. According to this theory, prices should drop back below US$100/barrel in early 2009. According to Desjardins’ economists, in combination with a more stable greenback, sliding oil prices will stop the loonie from going any higher, and make it oscillate in the US$0.95 to US$1.05 range until the end of next year.

“We anticipate that the S&P/TSX will end 2008 with an increase of about 5%. We can therefore expect the index to fall by year’s end on the forecast drop in prices for oil and raw materials. In 2009, it should gain 6%, and we could see substantial volatility,” adds Mr. Dupuis.

In conclusion, Desjardins Group economists believe that the surge by crude oil and grain prices constitutes the most serious risk to the world’s economy at this point, especially as the economy has already been sapped by several concurrent shocks.

About Desjardins Group

Desjardins Group is the largest integrated cooperative financial group in Canada, with overall assets of nearly $150 billion, as at March 31, 2008. It comprises a network of caisses, credit unions and business centres in Québec and Ontario, and some twenty subsidiary companies in life and general insurance, securities brokerage, venture capital and asset management, many of which are active across the country. Drawing on the expertise of its 40,000 employees and the commitment of more than 6,500 elected officers, Desjardins offers its 5.8 million individual and corporate members and clients a full range of financial products and services. Its physical distribution network is complemented by leading-edge virtual access methods.

Tags: , ,