Economy still growing, but OECD warns Canada to prepare for possible shocks

OTTAWA -- Canada's economic expansion is continuing, but governments should be prepared to respond to possible foreign and domestic shocks that could send the recovery off track, a leading global organization warns.

The Organization for Economic Co-operation and Development gives mostly a passing grade to Canada's economy in a new outlook Tuesday, despite noting growth has been soft in the second half of 2012 and will remain so until mid-2013.

However, it warns Canada is not out of the woods yet. Beside the usual risks from Europe and elsewhere, the OECD says the domestic economy has become somewhat unbalanced since the 2008-09 recession.

The two big domestic risks, the OECD says, are the record level of debt Canadian families hold and their dependence on house prices remaining firm.

"Continuing high household debt levels could lead to a sharp deceleration in household spending, while a sudden weakening of the housing market could have sizable negative spillover effects," the OECD says.

Should the risks materialize, or Canada be hit from an outside shock, policy-makers should respond by increasing government spending if necessary, it said.

"Federal and provincial budget consolidation is needed and welcome, but if new shocks were to weaken underlying growth materially, the pace of debt reduction should be slowed," the OECD recommends.

As things stand, the organization said the Bank of Canada may need to start raising interest rates from near record lows by the latter half of 2013.

The report was written before the announcement Monday by Mark Carney that he was leaving his post as governor of the central bank next June for the top job at the Bank of England.

Scotiabank economist Derek Holt says the move makes it more likely the Bank of Canada will become hesitant to change course during the transition period.

"The Bank of Canada has a very strong team, but it is difficult to imagine a bias change amid leadership uncertainty and in the early going for Carney's successor," Holt said in a note to clients Tuesday morning.

"This is a further factor in favour of our view that the BoC will remain on hold until 2014 with the bigger risk being later rather than sooner as housing comes off the boil and the trade picture remains under pressure."

Overall, the OECD projects Canada's economy will grow by 1.5 per cent in the final three months of this year and advance only 1.8 per cent in 2013.

Next year's projection is half a point below the Bank of Canada's official forecast, although the two institutions agree that 2014 will see an improvement to 2.4 per cent growth.

Mostly, the report mirrors assumptions of the Bank of Canada in its last policy review in October in putting most of the blame on Canada's snail-paced economy on the export front, with soft demand outside Canada, low commodity prices and the high dollar undermining activity and corporate profits.

"(Export) activity moderated in the second half of 2012 to below the estimated potential growth rate," the OECD said. "This reflected a softening of commodity prices, which curtailed profits and investments in the fast-growing resource sectors."

Last week, Finance Minister Jim Flaherty cited lower commodity prices for taking some of the air out of tax revenues, delaying Ottawa's return to balance budgets by a year.

Since then, however, both Flaherty and Prime Minister Stephen Harper have said the government can still eliminate the deficit by 2015-16, barring any unforeseen shocks that throw Ottawa's best estimates off course.

Despite the diminished expectations, Canada's expected growth rates remain above the average of the 34 countries measured by the OECD, which includes most of the industrialized world. China and India are not part of the grouping.

The report's outlook for the world is decidedly bleaker than for Canada, pointing out that after five years of crisis the global economy is again weakening and risks proliferate.

"The risk of a new major contraction cannot be ruled out," said Pier Carlo Padoan, the OECD's chief economist, citing the ongoing recession in the euro area, a below-par economy in the U.S. and a slowdown in many emerging markets.

Referring to the problems in Europe, he said it is "not difficult to imagine a situation in which something goes wrong."

If that happened, Canada would be impacted through trade, financial market and confidence channels, the OECD said, but noted that the country is much more dependent on the U.S., whose economy is better balanced.

In fact, the OECD anticipates the U.S. economy will speed up faster than Canada's next year at two per cent and in 2014, at 2.8 per cent growth.

Because the U.S. is starting from further behind, Canada will still maintain an advantage in the recovery over its southern neighbour, however. For instance, the organization projects Canada's unemployment rate will fall below seven per cent by 2014, while in the U.S., it is expected to remain close to eight per cent.