TD Bank Financial Group predicted that rising interest rates will temper global economic growth and will shape the performance of financial markets in the coming quarters, according to the June issue of the TD Quarterly Economic Forecast.
"In Canada, the Bank of Canada is clearly concerned about price pressures - and recent economic developments suggest that it should be, " TD's statement read.
The economy was operating at full capacity at the end of last year and real GDP surged at 3.7 per cent in the first quarter of 2007. The result has been a state of excess demand, as seen with an extremely low unemployment rate and an upward drift in core inflation away from the Bank of Canada's two per cent target. As a result, the bank is poised to raise rates, likely on July 10 and September 5.
TD also predicted the Canadian dollar would average 96 US cents in the second half of 2007.
The combination of higher interest rates and the higher Canadian dollar will lead to a slower pace of economic growth and a 2.5 per cent increase in real GDP in 2008. "This may look like a disappointing performance and it is likely to lead to many comments about how Canada is experiencing an economic slowdown. The reality is very different, " said Mr. Drummond.
"Given Canada's dismal productivity performance in recent years, there is a possibility that potential growth is even slower, " the statement read.
In the months ahead, every G-7 central bank (with the exception of the U.S. Federal Reserve) will increase their rates. This is a tighter stance than financial markets had expected until only a few weeks ago when rate cuts were anticipated.
TD's forecast predicted the global economy will ride out the higher interest rate, but markets could experience greater volatility as investors adjust and equity markets are unlikely to replicate the double-digit gains of the past few years.
"The trillion dollar question is how the world economy and global financial markets will adjust to higher borrowing costs, " stated the report.
Over the past five years, the global economy has been on a tear, but technological innovation and the disinflationary impact of globalization has kept inflation at bay. However, capacity constraints are increasingly being encountered. In some emerging markets, such as China, the impact is being felt in asset prices. In developed nations, the result has been very tight labour markets, even in the United States, which is experiencing slower growth.
"The good news is that monetary authorities are being proactive and are raising rates before inflation gets out of hand, reducing the risks of an economic downturn, " said Mr. Drummond. "While the global economic expansion will be dented by the rebalancing in monetary policy, it should not be thrown off the rails. "
The fallout from higher rates in the near term should be largely felt in the second half of 2008 and early 2009, with world real GDP slowing to a still robust 4 per cent.
The report can be found at www.td.com/economics.
