OTTAWA (Reuters) - High commodity prices will help Canada avoid a recession this year but a U.S. slump will pull down economic growth to 1.4 percent, about half last year's rate and below official forecasts, Royal Bank of Canada said on Thursday.
After an unexpected contraction in the first quarter of an annualized 0.3 percent, the economy will fare better in the remainder of the year due to support from consumer spending, business investment, an easing of financial market pressures and high prices for energy and other natural resources, the bank predicted in its revised forecasts.
"Domestic demand is holding up and will more than offset the significant drag from net exports this year," it said.
The economy expanded 2.7 percent in 2007.
The bank's 2008 outlook is less rosy than that of Finance Minister Jim Flaherty, who has maintained his growth forecast of 1.7 percent. In an April Reuters poll, RBC had forecast 2008 gross domestic product growth of 1.6 percent.
But RBC's outlook for second-quarter growth remain fairly upbeat compared with the Bank of Canada's latest projections. RBC calls for 1.5 percent second-quarter growth, while the central bank expects growth of just 0.3 percent in the quarter, according to an April report by the Bank of Canada that will be updated this month.
Nearly half of Canada's exports are commodities that are in hot demand from markets such as China, while most imports are in the consumer and investment goods category for which prices are falling.
"The result of this terms-of-trade boost is that Canadians have experienced a lift to their incomes on rising export earnings," RBC said.
Still, exports should decline 2.8 percent in volume terms this year while imports rise 2.9 percent, RBC said. That drag on GDP will begin to lessen as the U.S. economy strengthens next year, it said.
Saskatchewan leads the pack with estimated 2008 growth of 3.7 percent, followed by Alberta with 3.1 percent.
"Saskatchewan is in the fortunate position that nearly all of its major commodity exports, including oil, grain, uranium and potash, are at historically high prices," RBC said.
Ontario will eke out growth of just 0.7 percent, it said.
RBC is less worried about inflation than the Bank of Canada, which said last month consumer inflation would rise past 3 percent later this year and drop to 2 percent in 2010.
RBC sees inflation peaking at 2.5 percent in the remainder of this year. "However, as oil prices trend lower through next year, CPI inflation is expected to drop below 2 percent in 2009 on an average annual basis," it said.
Bank of Canada interest rates will remain on hold at 3 percent in the near term, it predicted, and the Canadian dollar will finish 2008 with a value of US$0.94.
Reporting by Louise Egan; Editing by Peter Galloway