Canada's Finance Minister Jim Flaherty
Credits: REUTERS/CHRIS WATTIE
OTTAWA - A last-minute deal by American legislators to avoid the much ballyhooed fiscal cliff doesn't mean Canada's economy is safe from a broadside.
While stock markets reacted favourably Wednesday to the deal struck in US Congress on New Year's Day, economists and Finance Minister Jim Flaherty caution the Canadian economy is still vulnerable to inaction and squabbling.
"Canada welcomes the agreement reached between the president and the Congress that protects the US economy in the short term," Flaherty said.
"That said, there remain a number of significant risks to the US economic outlook. It is my hope that leaders in the United States continue to work together to develop future action that will put the US fiscal position on a sustainable path."
Flaherty has warned that if the American economy tanks because of partisan bickering and falls into recession, Canada could follow.
Tuesday's 11th-hour compromise that stops taxes from increasing on mostly middle-class earners, but delays deep spending cuts for at least two months, still leaves considerable economic and policy uncertainty, say experts.
"We're just at the 100-metre mark of this relay race," said Beata Caranci, vice-president and deputy chief economist at Toronto Dominion.
What concerns economists is a fiscal storm - the combination of addressing $110 billion in spending cuts at the same time when the $16 trillion US debt ceiling limit is maxed out. That could happen in late February or March.
"Based on the 2011 experience, if these negotiations overlap and run down to the wire, it will likely inject another hefty dose of uncertainty into financial markets and restrain the economic recovery," she said, referring to the financial crisis that sent stock markets plunging and eroded investor and consumer confidence.
"The lack of clarity on spending cuts could result in a persistence of under-investment by firms, particularly those still caught in the spider web of negotiated political outcomes."
Those include defence and health care - two areas targeted in spending cuts and companies dependent on procurement contracts.
Paul Ferley, assistant chief economist at Royal Bank, said the vote to reverse income tax hikes lowers the threat of a recession, and it's too early to say how the spending and debt issues will play out.
"I'm not saying there's not a risk, but it's diminished with what was agreed to. It's not as a worrisome environment that we had been looking at."