TD Bank 2007 Annual Report Download - page 31

TD BANK FINANCIAL GROUP ANNUAL REPORT 2007 Management’s Discussion and Analysis 27
ECONOMIC SUMMARY AND OUTLOOK
The Canadian economy faced a more challenging environment
in 2007, but still managed to come through with an outstand-
ing performance. The export sector was severely impacted by a
rising Canadian dollar and slowing U.S. demand. By extension,
job losses continued to increase in the manufacturing sector.
However, the domestic sectors in the economy performed very
well, more than offsetting weakness emanating from the exter-
nal sector. The biggest contributor to the Canadian economy
was consumer spending, which was supported by 30-year low
unemployment rates, strong gains in wages and gains in home
equity due to further price appreciation. On the corporate side,
profits as a share of the national economy were near record
highs, while the high Canadian dollar provided a boost to
imports of machinery and equipment midway through the year.
Overall economic growth is likely to average about 2.6% in the
year, which is just below the long-term trend rate.
Although credit conditions tightened around the world over
the summer, as financial markets became increasingly skittish
over asset-backed commercial paper (ABCP) and related prod-
ucts, the financial turmoil occurred at a time when the
Canadian economy was healthy enough to withstand the shock.
In fact, the domestic economy was so strong that the Bank of
Canada raised interest rates by a quarter point in early July. Had
it not been for the turmoil that emerged in financial markets
soon after, the central bank would likely have followed up with
one or two more quarter-point rate hikes. Rather than the Bank
of Canada taking explicit action to tighten monetary conditions
by raising the bank rate, tighter conditions in the credit markets
and the rise in the Canadian dollar had the similar effect.
The same cannot be said for the U.S. economy, which was
already suffering from a backsliding housing market. Economic
and financial conditions became increasingly less supportive to
banking over the course of the year, as a rapidly deteriorating
housing market remained the catalyst to a sub-par economic
performance of only 2% in fiscal 2007. Tighter credit condi-
tions due to financial turmoil threatened to further undermine
economic activity. Although the Federal Reserve cut interest
rates in response, it will not be sufficient to revive the housing
market which remains plagued by high inventory levels,
suggesting another year of weakness remains in store.
Canadian economic growth is expected to slow down to
2.3% in 2008, with the U.S. economy turning in a similar per-
formance. The economic drivers behind each country, however,
are expected to be mirror opposites. The external sector poses
the biggest downside risk to the Canadian economic outlook.
The high Canadian dollar and weak U.S. demand will continue
to undermine exports, acting as the principal drag to economic
growth in the upcoming fiscal year of the Bank. The economic
offsets will come from the domestic sectors, where consumers
are expected to benefit from continued solid wage growth and
home price appreciation in the majority of markets. Unlike the
U.S., housing markets in Canada were built on sounder founda-
tions, reflected by the fact that subprime mortgages in Canada
make up about 3% of total outstanding mortgages and 5% of
all new mortgages issued in 2006. In the U.S. the equivalent are
estimated to be 15% and 25%. In addition, the high Canadian
dollar should give business investment a lift considering that
the vast majority of machinery and equipment is imported
and the cost of that capital is discounted under a high
Canadian dollar.
The U.S. experience will be the opposite of Canada’s. Much
of the weakness will likely continue to emanate from domestic
sectors – predominantly residential construction and consumer
spending. The unwinding of housing wealth effects in combina-
tion with almost no home price appreciation is expected to
dampen consumer spending. However, given that the U.S.
economy experienced significant job restructuring at the start
of the decade, we do not anticipate a repeat performance in
the current economic slowdown. As a result, consumer spend-
ing is expected to slow, but not decline, as wage growth will
likely continue to outpace inflation. Unlike Canada, the export
sector in the U.S. is expected to remain a key area of strength.
The depreciation of the U.S. dollar against its major trading
partners should continue to boost export growth.