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Canada's economy is expected to grow at a moderate pace over the next several quarters but risks to the outlook are mostly negative due to headwinds from the European debt crisis, the International Monetary Fund said on Thursday.
The multinational agency said it expects Canada's real gross domestic product to slow to 2.2 percent in 2011 and 1.9 percent in 2012. But it said one big downside risk is the spillover effect of the European crisis on financial markets and global growth.
"Direct trade linkages with Europe are there. They're not very large so we would not expect a very large impact from a decline in European demand for Canadian product," said Gian Maria Milesi-Ferretti, IMF Mission Chief to Canada.
"More of concern are the potential global financial market repercussions of turmoil in Europe and there is a lot of uncertainty about that, so again we see those threats not so much coming from direction of say direct exposures of Canadian banks to euro area financial institutions for example, but more through the impact that this global financial market turmoil would have more generally."
The Fund approved of the Bank of Canada's current accommodative stance -- its key interest rate sits at 1 percent -- but noted there is scope for further monetary easing if the economy weakens.
It also applauded the federal government's plan to balance its budget in the medium term, but again said there was room for further stimulus if the economy ran into trouble.
The IMF warned that high household debt levels and elevated house prices are the main domestic vulnerability, the same risks it cited a couple months ago.
In a special report on house prices and household wealth, the IMF estimated that house prices are higher than levels consistent with fundamentals in some provinces. It projected that a potential 10 percent correction in prices would lead to a 1-1/4 percent drop in private consumption.
With interest rates still very low, the IMF noted that growth in personal consumption and real estate investment should be subdued, in light of high household debt and measures taken to restrain mortgage debt and cool the housing market.
The IMF credited Canada's accommodative financial conditions and strong commodity prices for previously supporting the domestic economy, but -- like the Bank of Canada -- warned that businesses will need to step up investment to pick up the slack from weak net exports and ongoing fiscal challenges.
It also said the fund's staff's assessment of the Canadian dollar found it to be on the strong side of medium-term fundamentals.