The Hits and Misses of 2007

In 2007, Canadian and U.S. Growth Rates Will Be Weaker

Our most important forecast for 2007 was that it would be a year of relatively weak economic growth for both Canada as well as the United States, but more-so for the United States. At the end of last year, the Canadian economy appeared to have grown at 2.8% in 2006, and we forecasted a fall to 2.3% for 2007. The Canadian economy was growing at a very slow pace at the end of last year, but the economy was operating beyond capacity. The U.S. economy grew about 3% in both 2005 and 2006, and Global Insight forecasted a tumble to 2.2% for 2007. It is important to note that a year ago, before the "financial turmoil" of October 2007 set in, the U.S. housing market was forecasted to be very weak in 2007 and consumer sentiment and spending was expected to cool down considerably. This weaker growth in the United States, especially since it was centered in the housing sector, was forecasted to be a major drag on Canada's growth for 2007.

It now appears that 2007 was slightly kinder to Canada than expected a year ago. Our growth is now expected to come in at 2.6%, in spite of growth in the United States being as weak as forecasted, at about 2.2%. Indeed the housing sector in the United States was even slightly more miserable than forecast, with housing starts in 2007 only 74% of their 2006 level. For Canada, higher-than-forecast energy prices added a bit of a boost, pushing Canada's growth for 2007 to 2.6%, relative to the 2.3% forecast a year ago.

For the First Time in Five Years, in 2007 the Canadian Dollar Will Not Appreciate

Now for the bad news, at least from the forecasting perspective. From the end of 2002 to the end of 2006, the Canadian dollar appreciated from 63.7 cents U.S. to 87.8 cents U.S. This appreciation was relentless, with the dollar appreciating significantly each year for a cumulative total of 38%.

At 88 cents, the Canadian dollar was in the range of purchasing power parity and consistent with oil prices in the WTI $65 range. A year ago oil prices were forecasted to remain in the WTI $65 range for 2007. While the upside risk of a higher Canadian dollar in 2007 from higher energy prices and/or general downside pressure on the U.S. dollar were clearly recognized, our forecast a year ago was that the Canadian dollar would average about 88 cents in 2007, close to its 2006 average.

As 2007 unfolded, it initially appeared the Canadian dollar would fall short of our forecast of 88 cents. In February 2007, the Canadian dollar fell almost to 84 cents before embarking on a fairly steady and surprising climb to par in mid-September, and a peak close to 109 cents U.S. in early November 2007. While many factors pushed the Canadian dollar upwards between March and November 2007, higher energy prices and a general decline in the U.S. dollar were most significant. A year ago, WTI oil was forecast to average about $65 over 2007 relative to the $72 actual. There was a bit more shrinkage in the Canada/U.S. interest rate gap than expected over 2007, also adding to the upside pressure on the Canadian dollar in 2007. Over 2007, the U.S. dollar, relative to other major trading partners, will average about 94% of its 2006 level; very close to forecast.

All told, the Canadian dollar will average 93.5 cents U.S. in 2007, well beyond the 88 cents forecast a year ago. Rather than being flat in 2007, the Canadian dollar will appreciate 6%, very similar to the appreciation in each of the past three years. Incidentally, Global Insight is forecasting an appreciation of 7% for the Canadian dollar in 2008 over 2007, driven of course by economic fundamentals, rather than our wrongful foray into undue pessimism in 2007.