What 2008 holds for the Canadian economy

The new buzz word among economists in recent weeks has been "decoupling." With the American economy slowing, the big question now is whether the rest of the world will follow suit as it usually does, or whether other countries are sufficiently decoupled from the US that they can continue to grow without support from American consumers.

Nowhere is the decoupling question more relevant than it is in Canada. Close to 25 percent of Canadian Gross Domestic Product, or GDP, ends up as exports to the US, so if our biggest customer catches a cold, we tend to get pneumonia. According to one expert, things aren't likely to be any different this time around.

"Canada's economy is headed for weaker times in 2008," said Craig Alexander, deputy chief economist at TD Financial Group, in a recent note to clients. "The good news is that Canada is well positioned to weather the storm. The domestic economy remains solid and the risks in the real estate market remain limited."

Although the Indian and Chinese economies remain exceptionally robust, "the correlation between overseas economic growth and US consumer activity has remained strong," says Alexander. "This implies that the coming tightening in American purse strings will act as a major dampening factor." Alexander expects world GDP growth to slow from 5.2 percent in 2007 to 4.2 percent in 2008. Canadian growth is expected to slow to 1.9 percent in 2008 before bouncing back up to 2.5 percent in 2009.

A dose of preventive medicineAccording to Yanick Desnoyers, a senior economist at National Bank Financial, the Bank of Canada's move to cut interest rates earlier this month may prove to be prescient. The strong loonie, coupled with tighter credit south of the border, is putting a crimp in the growth of Canadian exports. The fact that domestic inflation remains well contained gave the central bank room to act earlier than it might otherwise have.

"In terms of domestic demand, the U.S. economy is ambling, while Canada is running full steam," comments Desnoyers. "In stark contrast with the situation south of the border, house prices here continue to climb, with the resulting real estate wealth and a strong job market providing solid support for consumption growth. However, with the US consumer almost completely tapped out, the risks that Canadian exports will be hit hard are much higher than many believe."

Recent real estate performanceOne area that has done quite well recently, but which could see some cooling off next year, is house prices. According to the Canadian Real Estate Association, or CREA, existing home sales in Canada reached record levels during the first 11 months of this year. The average price of a home sold via the association's Multiple Listing Service, or MLS, rose by an impressive 11.6 percent to $332,807 in November.

According to one CREA spokesperson, worries that the effects from the sub-prime loan debacle in the US would spread to Canada's housing sector have yet to be confirmed. "Our association has not received any reports from realtors that creditworthy homebuyers are having difficulty getting mortgage financing as a result of the sub-prime meltdown," says Anne Bosley, CREA's president.

Housing starts also remain strong and ran at an annual rate of 227,900 units in November, a pace that is almost unchanged from the previous month. That said, the rate of growth in the selling price of new houses slowed again last month for the 14th consecutive month. According to Statistics Canada, contractors' selling prices for new homes rose by 6.1 percent between October 2006 and October 2007, down from a 6.2 percent year-over-year increase the previous month.

Existing home prices have now risen in the double digits for the past three years. However, despite the Canadian real estate market's impressive numbers, Douglas Porter, an economist with BMO Capital Markets, believes that that strength is unlikely to continue forever. That said, the slowdown will be moderate. "Housing may not manage to pack as strong a punch next year as it did in 2007 for the Canadian economy," says Porter. "But it's also unlikely to suffer a knockout blow, a la the US market over the past year."

In short, while the US economy may not be completely decoupled from Canada's, Canadian homeowners can at least rest assured that for the time being, their real estate market looks like it is.

By Peter Diekmeyer of Bankrate.com