Global headwinds threaten Canadian recovery

Canadians should brace for months, possibly years, of tepid growth that for many will feel like the brutal recession never ended.

While the most dire of scenarios would see the global economy plunged back into a slump, the most likely outlook is that Canada is held back by a weak U.S. recovery and a European debt crisis that refuses to go away and threatens to stall the continent's economies for an extended period.

Friday's labour market report from Statistics Canada – the unemployment rate crept up to 7.3 per cent amid 5,500 job losses – was just the latest sign that malaise on both sides of the Atlantic and volatility in financial markets are holding the domestic economy back.

The Bank of Canada, the Organization for Economic Co-operation and Development, and most analysts believe that growth has resumed in Canada after stalling in the second quarter. But few expect much more than stagnant growth in key markets, such as the U.S. and Europe, for quite some time. And that likely means little if any meaningful change in incomes, employment or the consumer spending that makes up most economic activity in developed countries for years as well.

If the U.S. or Europe were to actually succumb for a second time, Canada would not stay ahead for long, just as it couldn't escape the fallout of the financial crisis and global recession.

But what's most likely to happen is that American and European policy makers manage to keep their economies sputtering along. But failure to spur noticeable gains or boost confidence could translate into piddling growth indefinitely, similar to Japan's fate for the better part of two decades.

"I don't see a crisis again, and I'm not even sure I see a double-dip," said Christopher Ragan, an economics professor at McGill University in Montreal who was a guest academic at the Finance Department for 18 months that included the 2009-10 recession.

"But what's almost as bad, frankly, is just chugging along at, say, 1.5-per-cent growth. That's growth, but meanwhile the labour force is growing at 1 per cent. So that means unemployment starts to rise."

Canada is at an enviable starting point, at least compared to the United States, with a jobless rate of 7.3 per cent compared with 9.1 per cent south of the border. Canada also regained the jobs lost in the slump, while some six million Americans are in the ugly category of "out of work for six months or more," watching their skills, self esteem and financial well-being erode.

Still, with the economy expected to show subpar annual growth of 2 per cent for the foreseeable future, well below the precrisis 20-year average of 2.8 per cent, unemployment won't improve much.

"At best we would see a little bit of further edging down in the jobless rate, but not much," said Doug Porter, deputy chief economist at BMO Nesbitt Burns in Toronto.

What could make matters worse is fear among Canadian businesses of worsening conditions, even if those conditions don't deteriorate much. The last thing the country needs now is a pullback in private sector investment needed to power the recovery.

The more dire scenario would see the U.S. economy sinking deeper, or Europe's debt crisis engulfing its banking system as austerity strangles growth and fuels more social unrest. That could push Canada into reverse.

In an extreme scenario, global demand for oil, metals and other commodities that Canada produces could plummet as China and other rapidly growing emerging markets slow down. The Bank of Canada warned last week that growth in those countries "will be affected by weakness in major advanced economies," so it's clear that a new slump in the developed world would mean less development in developing nations.

"The investment story is hanging very much on a high level for commodity prices, so that producers are still above their break-even point," noted David Madani of Capital Economics in Toronto. "To a large extent, it's all about what happens to the price of oil.'' All that said, there is a third scenario.

Mr. Obama and Federal Reserve Board Chairman Ben Bernanke might find the right mix of fiscal and monetary stimulus to get the world's most important economy growing more like it used to. The European Central Bank and leading euro-zone countries like Germany and France might manage to contain the debt crisis, and a more measured approach to belt-tightening could give a much-needed jolt to the continent's weakening economies.

Mr. Porter pointed out that sentiment in the U.S. and Europe was dropping like a stone last August and September, only to bounce back with impressive force by the end of 2010.

"It's not impossible that could happen again," he said. "Whether that actually translates into a much more robust recovery is less likely.''

And Bank of Canada Governor Mark Carney will continue to have trouble finding appropriate moments to raise his main interest rate, currently at 1 per cent, even as he worries about some households amassing debt that won't be affordable when borrowing costs eventually do rise.