But recovery has legs; Bank lending at solid clip in Canada, growth in U.S. credit

Paul Vieira, Financial Post

OTTAWA - Europe is a mess and markets are not thrilled about what they see or hear from the continent's policy-makers, judging by the global sell-off in stocks and commodities.

Still, there is reason to believe the global recovery has legs, even if it moves at a slower pace.

For starters, European uncertainty may slow attempts by Beijing to tighten Chinese credit conditions, which had traders worried about near-term emerging market demand. Bank lending continues at a good clip in Canada, and credit growth in the United States is slowly picking up. Long-term U.S. mortgage rates have moved to near-record lows, and even the sharp drop in crude oil prices, which will take a bite out of Canada's terms of trade, means more money in the pockets of that ever-important U.S. consumer.

"There's a lot of turmoil, but I don't know that I am prepared to throw in the towel and say we will have a big follow-through economic impact," says Stewart Hall, economist at HSBC Securities Canada.

Events in Europe, however, do foreshadow what's ahead -- namely, slower growth for the developed world as it deals with the massive amount of debt built up prior to the financial crisis, and piled on with zest in efforts to avert the next Great Depression.

"In the near term, the Canadian economy will be in healthy shape," says Avery Shenfeld, chief economist at CIBC World Markets. "But we are going to see the story of fiscal tightening hit much more important economic partners for Canada -- like the U.S. and Britain next year -- and that may slow growth more than we would like."

Make no mistake, Europe is a big economic deal. The eurozone, or the countries that use the euro, represents 16% of global gross domestic product.

But even before Europe got itself into trouble -- mostly over the handling of a potential Greek default -- the Bank of Canada had pencilled in weak growth for the economic bloc of just 1.2% this year and 1.6% in 2011.

Further, the eurozone plus Britain accounted for 8.6% of all Canadian exports shipped in the past 12 months.

Nevertheless, Europe's woes are beginning to ripple. The Canadian dollar took a hit and yields on Canadian bonds fell yesterday.

Market participants scaled back expectations of Bank of Canada rate increases on the belief the economy might sputter due to events across the Atlantic.

Douglas Porter, deputy chief economist at BMO Capital Markets, says the Asian crisis of the late 1990s caused "much sound and fury" in North American markets, just as Europe has this week.

But at the end of the day, the U.S. economy "kept chugging through as if nothing had happened," Mr. Porter said.

"Europe is important, but the U.S. economy is big enough to stand on its own. And the more crucial factor, going forward, is if U.S. employment keeps climbing."

One drawback from the euro troubles, though, is the rapid strength of the U.S. dollar.

Much of the anticipated U.S. economic comeback was based on its emergence as an exporting powerhouse by building on a weaker currency and the U.S. propensity to extract productivity gains.

What's got markets spooked is the possibility that Europe's fiscal malaise represents a return to yet another global recession. But credit markets continue to function and interest rates remain near record lows, Mr. Hall says.

"Are we seeing real changes in long-term demand trends? I don't think so," Mr. Hall says.

"That tends to suggest we get a commodity price recovery once markets get their heads around the fact this may not be the great economic development that the sub-prime meltdown was."