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Canada’s recovery not much threatened by weakening European markets: economists

Date: Tuesday, June 1, 2010
Author: Investment Executive

Canada’s trade surplus in the first quarter could fade as the debt crisis in Europe drags on, but the Canadian economy will likely emerge with relatively few bruises thanks to weak ties to the old continent, economists say.

The problems plaguing so-called PIGS countries _ Portugal, Ireland, Greece and Spain _ will mean slower growth in Europe as they get their fiscal houses in order.

That will take a modest toll on strengthening Canadian exports and commodities, which were showing signs of major improvement before massive debt problems in Greece began to wreak havoc on international markets late last month, economists said after reviewing new trade numbers released Friday.

But CIBC economist Krishen Rangasamy said Canadian trade figures are expected to outperform most other countries, given the country’s relatively weak linkages with the eurozone, which accounts for just 4% of total Canadian exports.

“Unlike the tie to the U.S., when Europe sneezes, Canada does not necessarily catch a cold,” Rangasamy wrote in a report. “That’s because trade linkages between Canada and the old continent are not as vital as the ones we have with the U.S.”

Canadian exports rose more than imports in the opening quarter of 2010, suggesting that Canadian trade was accelerating _ helped especially by a growing surplus with No. 1 trade partner the United States.

Statistics Canada reported Friday that Canada’s goods surplus hit $1.7 billion in the first quarter of 2010, as the goods surplus with United States continued to expand for the second quarter in a row.

The country’s seasonally adjusted deficit on current transactions with the rest of the world narrowed to $7.8 billion from $10.2 billion in the fourth quarter of 2009, thanks to a larger surplus in goods trade and a reduced deficit in international travel.

And an increase in purchases of Canadian securities and foreign direct investment in Canada suggested investor confidence in Canada’s relatively stable currency, banking system and domestic economy.

Douglas Porter, deputy chief economist at Bank of Montreal (TSX:BMO) said the current account deficit narrowed in the first quarter more than economists had expected.

Another good sign for the resource-powered economy was Scotiabank’s monthly commodity price index, which climbed 4.2% in April amid higher prices for metals and minerals.

But the bank warned this could be the “high-water mark” for 2010 and other economists say sluggishness in the European economy will have an indirect impact on Canadian growth as it continues to dampen demand for commodities for months to come.

The prices of copper, zinc and nickel fell by almost 25% between early April and mid-May before recovering a bit in recent days. The drop was primarily due to jittery investors moving out of commodities into the relative safe haven of U.S. Treasuries and gold.

The flight to safety was in response to fears that new austerity measures in some debt-saddled European countries would combine with moves by China to cool its housing market and slow the global economic recovery.

Slow growth in Europe could halt some manufacturing in Asia, where Canadian raw materials _ from copper to lumber _ have been in high demand, contributing to higher commodity prices and improving performances from Canada’s resource sector.

Rangasamy said the direct impact of softer growth in Europe is unlikely to do much to derail Canada’s recovery, but added there could be a larger, indirect one.

“For instance, economies with bigger exposures to Europe, such as Asia will be somewhat slower as a result, cutting into volumes and prices for Canada’s exports.”

Porter said BMO revised its Canadian growth forecast down just slightly, by one-tenth of a per cent, after the European debt crisis hit.

He said Canada is well-insulated from a direct effect, but will feel a moderate indirect one from weaker global demand for commodities, which make up about half of Canada’s total exports.

“Sometimes what can hurt the trade deficit, like a decline in the commodity prices, can also lead to a lower Canadian dollar, which can ultimately help the trade numbers down the line, so there’s some offsetting forces at play,” Porter said.

He said there will be a slight softening in trade numbers in the second quarter, partly because of a drop in commodity prices, and partly because strong domestic spending is driving an influx of imports.

Porter said he wouldn’t be surprised if the current situation followed a similar pattern as the 1997-1998 financial crisis in Asia, when the Canadian economy remained quite strong despite the effect the crisis had on global markets.

“Worries about Europe can have very real effects on our financial markets, on commodity prices, even on our currency like we’ve seen, and yet really not make that big of a dent in terms of our broader growth numbers,” he said.

And, as more countries get muddied by concerns over high government debt, it could further burnish Canada’s already strong economic standing.

“But by no means should Canadians be cheered up by the problems these other countries are having...it might make our star seem a little bit brighter, but that’s only in relative terms,” he said.