BMO Financial Group - Outlook 2005(1.1Mb pdf File) - Boardwalk REIT

OUTLOOK 2005
United States Outlook ......................................................................................................... 3
A solid expansion, bolstered by declining oil prices next year,
will be tempered by rising interest rates
Canada Outlook ................................................................................................................... 9
The economy will strengthen as the negative impact of the past
appreciation of the loonie on growth dissipates
Canada’s Regional Outlook ............................................................................................... 15
Easing, but still high, commodity prices provide a boost to resource-rich
regions
World Outlook ..................................................................................................................... 26
Global growth should stay firm despite higher oil prices
Oil Price Outlook................................................................................................................. 30
High market prices, driven by capacity constraints and supply
disruption fears, should slowly ease next year
Economics Department
BMO Financial Group
Tim O’Neill, Chief Economist
Rick Egelton, Deputy Chief Economist
Global Macro and Financial Analysis
Paul Ferley, Assistant Chief Economist
Barney Bonekamp, Senior Economist
Sal Guatieri, Senior Economist
Laurie Peterson, Senior Economist
Research Technology and Design
Tario Cham, Senior Technology Specialist
Clara Lo, Research Analyst
Gregory Sweeney, Research Analyst
Mark Williams, Research Analyst
Industry and Regional Analysis
Earl Sweet, Assistant Chief Economist
Robert Hogue, Senior Economist
Kenrick Jordan, Senior Economist
Financial Services Analysis
Elizabeth Wirth, Senior Economist
Administration and Support
Linda Gallant, Manager
Cora Meli, Administrative Assistant
Edited by Laurie Peterson
http://www.bmo.com/economic

© Bank of Montreal, 2004
This document is based on economic information available as of October 8, 2004.
The information in this publication is drawn from sources believed to be reliable; however, the Bank cannot
guarantee its accuracy and thus does not assume any responsibility or liability for it.

3
United States Outlook
Economy gains traction in 2004
So far, the recovery train remains on track
towards its destination – full employment –
despite losing some steam amid rising energy
costs. After expanding an outsized 4.4% in
2003, on a fourth quarter-over-fourth quarter
basis, the economy appears to be chugging
along at a 3.9% clip in 2004. Though
moderating from last year’s rapid pace, growth
has been high enough to gradually reduce the
jobless rate even in the face of phenomenal
productivity gains.
Businesses have ramped up spending…
Fueled by surging profits and still-low financing
costs, businesses have surpassed their
customers as the driving force behind the
expansion. Led by soaring demand for
productivity-enhancing information processing
equipment, business spending on equipment
and software soared 14.2% annualized in the
second quarter following an 8.1% spurt in the
first quarter. Recent rapid growth in shipments
of non-defense capital goods points to capital
spending increasing a further 10% in the third
quarter. As well, investment in new buildings
jumped in the second quarter, suggesting that
managers have gained confidence in the
recovery’s durability.
…while consumers have held their own
The economic powerhorse of the last three
years – the American consumer –downshifted
only slightly in 2004. In fact, the estimated
average pace of consumer spending in the first
three quarters of the year (3.1%) is largely
similar to that of the past three years. Flush
with larger tax refunds and spurred on by low
interest rates, personal consumption
expenditure advanced 4.1% annualized in the
first quarter. These two supportive factors
likely advanced purchases from later quarters
and, together with sharply higher energy costs,
slowed the pace of spending to 1.6% in the
second quarter. However, notwithstanding a
further run-up in oil prices, recent retail and
2003 2004 2005
Annual Average
Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 2003 2004 2005 2006
GDP (q/q % change ann.) 4.2 4.5 3.3 3.8 4.0 3.7 3.6 3.5 3.6
GDP (y/y % change) 4.4 5.0 4.8 3.9 3.9 3.7 3.8 3.7 3.6 3.0 4.4 3.7 3.6
CPI (y/y % change) 1.9 1.8 2.8 2.8 3.1 2.6 1.9 1.5 1.4 2.3 2.6 1.9 1.8
CPI core (y/y % change) 1.2 1.3 1.8 1.8 1.9 1.9 1.7 1.8 1.8 1.4 1.7 1.8 1.9
Unemployment rate 5.9 5.6 5.6 5.4 5.4 5.3 5.2 5.1 5.1 6.0 5.5 5.2 5.0
Fed funds 1.00 1.00 1.00 1.41 1.95 2.55 2.75 2.75 3.10 1.12 1.34 2.79 4.10
3-month Libor 1.13 1.07 1.25 1.73 2.15 2.75 2.90 2.95 3.30 1.17 1.55 2.98 4.29
3-month T-bill 0.92 0.92 1.08 1.49 2.00 2.60 2.75 2.75 3.10 1.01 1.37 2.80 4.10
Prime rate 4.00 4.00 4.00 4.41 4.95 5.55 5.75 5.75 6.10 4.12 4.34 5.79 7.10
2-year Treasury 1.86 1.69 2.45 2.56 2.90 3.50 4.20 4.60 5.00 1.66 2.40 4.33 5.33
10-year Treasury 4.29 4.02 4.60 4.30 4.70 5.00 5.20 5.40 5.50 4.02 4.41 5.28 5.73
30-year Treasury 5.22 4.98 5.40 5.15 5.20 5.30 5.40 5.60 5.70 4.95 5.18 5.50 5.93
30-year mortgage 5.93 5.62 6.11 5.90 6.10 6.50 6.70 6.90 7.10 5.82 5.93 6.80 7.33
10-year less 3-month T-bill 3.37 3.10 3.52 2.81 2.70 2.40 2.45 2.65 2.40 3.01 3.03 2.48 1.63
¥/US$ 108.8 107.2 109.6 109.9 109.0 108.0 105.0 103.0 102.0 115.9 108.9 104.5 99.5
US$/€ 1.191 1.250 1.205 1.222 1.240 1.250 1.270 1.290 1.300 1.132 1.229 1.278 1.323
US$/£ 1.710 1.840 1.810 1.820 1.800 1.810 1.820 1.830 1.830 1.635 1.818 1.823 1.833
Historical data Forecast data

4
The recovery has remained on solid ground in 2004...
Gross Domestic Product
Q/Q% Change, Annualized
8.0
7.0
6.0
5.0
4.0
3.0
2.0
1.0
0.0
-1.0
-2.0
2001:Q1
...with businesses now leading the way...
Equipment and Software Investment
Q/Q% Change, Annualized
25.0
15.0
5.0
-5.0
-15.0
-25.0
2001:Q1
...and households still spending briskly.
Personal Consumption Expenditure
Q/Q% Change, Annualized
8.0
7.0
6.0
5.0
4.0
3.0
2.0
Q3
2002:Q1
2003:Q1
2002:Q1
2004:Q1
Q3
FCT
FCT
2003:Q1
Non-residential Construction
Q/Q% Change, Annualized
15.0
5.0
-5.0
-15.0
-25.0
-35.0
2001:Q1
Q3
2002:Q1
Existing Home Sales
Millions of units, Annualized
7.0
6.5
6.0
5.5
2004:Q1
2003:Q1
FCT
Q3
2004:Q1
FCT
EST
auto sales figures point to a healthy 4¼%
rebound in personal consumption in the
third quarter.
Expansion to slow slightly in 2005…
Growth is poised to moderate somewhat
in 2005, though remain above potential.
Rising interest rates in 2004 and early
2005 are estimated to reduce growth by
three-quarters of a percentage point in
2005 on a fourth quarter-over-fourth
quarter basis. In particular, the still frothy
housing market should lose some steam
as rising mortgage rates undermine
affordability. Housing starts are poised to
pull back to an annual rate of 1.67 million
in 2005 from an estimated 1.91 million in
2004.
After topping US$52 per barrel in early
October 2004 – up from $32 a year ago –
crude oil prices are projected to retrace
to about $33 by late 2005. Nonetheless,
given both the contemporaneous and
lagged effect of rising prices on demand,
the run-up in energy costs will likely
subtract one-half of a percentage point
from growth in the second half of 2004
and the first half of 2005. By the second
half of 2005, falling oil prices should start
to support growth.
Fiscal policy is poised to contribute less
to economic growth in 2005 than in 2004
regardless of the outcome of the
upcoming presidential election.
Policymakers will need to tighten the
fiscal purse strings in order to rein in the
deficit.
1.0
0.0
2001:Q1
2002:Q1
2003:Q1
2004:Q1
5.0
2001:Q1
2002:Q1
2003:Q1
2004:Q1
Countering these negative factors,
growth will be underpinned by several
positive influences. Strong profit growth
and rising confidence in the sustainability
of the expansion should support business
investment. The past weakness in the
dollar, together with a strengthening

5
Rising interest rates...
10-year Government Note Rate
%
6.0
5.5
5.0
4.5
4.0
3.5
3.0
2002:Q1
Q3
2003:Q1
Q3
2004:Q1
...will temper the pace of expansion in 2005...
Q3
2005:Q1
FORECAST
Q3
2006:Q1
Q3
global economy, suggests that the
external sector will add to GDP growth in
2005 after subtracting from it in 2004.
In addition, though household debt has
risen to a record high relative to personal
incomes, assets have climbed even
faster largely as a result of rising home
prices and recovering equity markets. In
the second quarter of 2004, household
net worth stood at a record high US$45.9
trillion, up 11% from the year-earlier
period and 19% from the recent trough in
the third quarter of 2002. Therefore,
barring a downturn in asset prices, the
so-called “wealth effect” will continue to
support household spending in 2005.
Gross Domestic Product
Q/Q% Change, Annualized
8.0
7.0
6.0
5.0
4.0
3.0
2.0
1.0
0.0
2002:Q1
Q3
...though the jobless rate should decline further.
Unemployment Rate
%
6.5
6.0
5.5
5.0
4.5
2002:Q1
Q3
2003:Q1
Q3
Non-inflationary rate
2003:Q1
Q3
2004:Q1
2004:Q1
Q3
Q3
2005:Q1
2005:Q1
FORECAST
Q3
2006:Q1
FORECAST
Q3
2006:Q1
Q3
Q3
…but joblessness should still fall…
Continued above-potential growth should
allow the unemployment rate to drift
down from an expected 5.4% in the
fourth quarter of 2004 to 5.1% by the end
of 2005 and to 5.0% by late 2006. This
means the economy will be operating at
“full employment” – the jobless rate
associated with stable inflation pressures
in the long run – in about two years time.
…assuming that productivity
moderates
Despite the rapid pace of output growth
in recent years, job growth has been
surprisingly weak. From 2001Q1 to
2004Q2, real GDP expanded 9.1% but
nonfarm payrolls shrank by one million
workers. Firms managed to produce
more output with fewer workers because
of rising productivity. Output-per-hour
worked rose a phenomenal 14.8% over
this 3½-year span. If productivity had
grown a couple of percentage points
less, payrolls would have expanded by
more than one million.
If only because the recent pace is so far
beyond the norm, productivity growth is

6
Strong productivity growth...
Labour Productivity
Y/Y% Change, Nonfarm Business
6.0
5.0
bound to moderate in 2005, albeit to a
still healthy clip of 2%. Further out, we
see productivity growing at an estimated
long-run trend of 2½% in 2006 – a full
percentage point faster than the average
between 1975 and 1995. Factoring in
the usual 1% expansion of the labour
force, this implies long-run potential
growth of about 3½%.
4.0
3.0
2.0
1.0
2001:Q1
...has contained growth in jobs and labour costs...
Nonfarm Payroll Employment
M/M Change, Thousands
...thereby keeping inflation in check.
Consumer Price Index
Y/Y% Change
3.5
3.0
2.5
2.0
1.5
350
250
150
50
-50
-150
-250
Jan-02 Jul-02
1.0
2002:Q1
Q3
Q3
Historical Average
Jan-03
Jul-03
2003:Q1
2002:Q1
Jan-04
Q3
Jul-04
2004:Q1
Q3
Unit Labour Costs
Y/Y% Change, Nonfarm Business
-2.0
2001:Q1
Q3
3.0
2.0
1.0
0.0
-1.0
2003:Q1
2005:Q1
2002:Q1
FORECAST
Q3
Q3
2003:Q1
2006:Q1
2004:Q1
Core
Overall
Q3
2004:Q1
Inflation to remain controlled in 2005…
Rapid growth in productivity, by adding to
the economy’s productive capacity and
boosting profit margins, has helped to
keep inflation in check. Although rising
health care costs have pushed hourly
compensation up 4.2% in the second
quarter from a year earlier, unit labour
costs still managed to decline by 0.3%
owing to a 4.6% spurt in labour
productivity. Accordingly, cost pressures
have been subdued even in the face of
soaring resource prices and a weakening
dollar.
Inflation at the consumer level, as
measured by annual growth in the allitems
CPI, has risen in 2004, but only
moderately to 2.7% in August from 1.9%
at the start of the year. Most of the
increase has stemmed from the rising
cost of gasoline and other energy
products. An expected unwinding of
energy costs should allow inflation to
moderate to 1.9% in 2005. The “core”
CPI inflation rate, which excludes the
volatile food and energy prices, has also
climbed this year, but only to 1.7% in
August from 1.1% in January. The upturn
reflects higher costs of medical care and
shelter. The core rate is projected to
remain fairly steady at 1.8% in 2005 as
the persistence of a small margin of slack
in the economy should largely offset
upward pressure on import prices
stemming from the weaker dollar.

7
Tame inflation will allow the Fed to tighten slowly...
Federal Funds Rate
%
5.0
4.0
3.0
2.0
1.0
0.0
2002:Q1
...though rising US rates won't halt the dollar's descent...
US$ Trade Weighted Exchange Rate
Index Level, Against 7 Major Currencies
115
Q3
2003:Q1
Q3
2004:Q1
Q3
2005:Q1
FORECAST
Q3
2006:Q1
Q3
…abetting the Fed’s go-slow strategy
The Fed cut rates a cumulative 550 basis
points from early 2001 to mid-2003,
taking overnight rates down to a 46-year
low of 1.0% to bolster the economy’s
defenses against the ravaging effects of
the tech-investment bust and several
geo-political shocks. Policymakers then
paused for a year to assess the impact of
their actions on aggregate demand, all
the time pledging to step harder on the
monetary accelerator if the risk of
deflation mounted. In June 2004, with
the recovery gaining strength, the Fed
reversed course and lifted rates 25 basis
points. It warned that it would continue to
remove the policy accommodation, albeit
at a “measured” pace. Since then, the
Fed has stuck to its script, raising rates in
increments of 25 basis points at the
August and September policy meetings.
105
95
85
75
2002:Q1
Q3
2003:Q1
Q3
2004:Q1
2005:Q1
2006:Q1
...amid a rapidly worsening external position.
Current Account Balance
% of GDP
0.0
-1.0
-2.0
-3.0
-4.0
-5.0
-6.0
2003:Q1
2004:Q1
2005:Q1
FORECAST
2006:Q1
Q3
FORECAST
Q3
Net External Indebtedness
% of GDP
40.0
35.0
30.0
25.0
20.0
15.0
2002
2003
2004
FORECAST
2005
2006
Q3
2007
2008
Provided that growth remains at or above
potential, the Fed is expected to continue
lifting rates in bite-sized steps at each of
the next four policy meetings to March
2005. By then, with a full 175 basis
points of tightening under its belt,
policymakers will likely sit back to assess
the impact of their actions on the
economy. Though growth is poised to
moderate, the pace should remain
sufficiently high to deplete the slack in
the economy, assuming of course that
productivity gains moderate. By the fall
of 2005, the Fed should resume its
tightening cycle, slowly guiding the
federal funds rate to a more neutral level
of 4.5% by the fall of 2006.
Rising rates have bought the dollar
time…
The onset of Fed tightening in the
summer of 2004 acted as a safety net to
catch a freefalling dollar. After plunging
13% against a broad trade-weighted
basket of currencies from February 2002

8
US GDP Detail
US GDP Detail
2003 2004 2005
Q4/Q4 % Change
GDP 4.4 3.9 3.6
Consumer expenditure 3.8 3.4 3.0
Government expenditure 2.2 2.6 1.5
Residential construction 12.0 8.5 -8.8
Business investment 9.4 7.8 9.4
Non-res. Construction 1.5 1.7 3.6
Equipment & software 12.1 9.8 11.4
Imports 4.9 8.7 5.2
Exports 6.1 6.7 12.2
Levels- Annual (A), Q4 (Q)
Ch. in inventories (00US$bn,Q) 8.6 42.0 35.0
Housing starts (mn of units,A) 1.853 1.914 1.665
Current account bal. (US$bn,A) -530.7 -632.1 -586.3
to January 2004, the dollar firmed up through
the spring and summer. Faster economic
growth and narrowing rate spreads between
the US and several other countries, most
notably the Euro-zone and Canada,
underpinned the greenback. More recently,
however, doubts about the durability of the US
expansion in the face of rising oil prices have
kept the dollar on the defensive.
…but its long-run prospects look bleak
Movements in rate spreads will largely
determine the greenback’s near-term
performance. Rising US interest rates should
underpin the dollar until the spring of 2005, at
which time the Fed’s expected hiatus will have
the opposite effect.
A more significant influence over the longer
term is the growing US external debt. In the
second quarter of 2004, the nation racked up a
record shortfall in its current account equal to
5.7% of nominal GDP. To finance the gap
between domestic investment and savings, the
US relies on a steady inflow of foreign capital.
While net external debt – at 22% of GDP in
2003 – is far from alarming, it is projected to
expand to 36% of GDP by 2008. To stabilize
this trend, the dollar must depreciate further,
likely by 10 to 15 per cent on a broad tradeweighted
basis. Because it has already fallen
significantly against most of the major industrial
currencies, the next stage of adjustment will
mostly likely occur against the currencies of
emerging nations.
Economic risks appear balanced
With the recovery on solid ground, the risk of a
significant slowdown appears small – barring a
negative shock. Of prominent concern is that
crude oil prices might remain near current
record highs, or worse, head higher. Should
prices remain around $52 a barrel, economic
growth could downshift a further one-half
percentage point in 2005, on a fourth quarterover-fourth
quarter basis, relative to our current
forecast. This would likely keep the Fed
sidelined until well into 2005. As well, a
terrorist attack in the US could destabilize
business sentiment and the recovery. In this
event, the Fed might need to reverse course
and lower rates temporarily to shore up
confidence.
One possible upside risk to our growth outlook
for 2005 derives from the Fed’s go-slow
approach to policy renormalization. In the past,
this tactic has run the risk of the economy
growing too rapidly and overshooting its
capacity limits. Should this occur, the Fed
would need to boost rates aggressively, which
would lead to a sharper economic slowdown in
2006.
Sal Guatieri, Senior Economist
416-867-5258
sal.guatieri@bmo.com

9
Canada Outlook
Canada hit by numerous shocks in 2003…
2003 was Canada’s “annus horribilus.” The
economy was hit by a number of negative
shocks including: the SARS crisis, a ban on
Canadian beef exports, a hurricane in Atlantic
Canada, devastating forest fires in British
Columbia and a summertime power outage in
Ontario. These factors contributed to GDP
growth, on a fourth quarter-over-fourth quarter
basis, dropping to 1.7% from 3.8% in 2002.
…including the rapid rise in the C$...
Another factor that emerged in 2003 that
pressured growth lower was the sharp
appreciation of the Canadian dollar. The
currency strengthened most dramatically in the
first quarter but the upward trend continued
through the year. By the end of 2003, the
loonie was up 16% relative to the US dollar.
…which sent exports lower
Consistent with the rise in the Canadian dollar,
exports fell in 2003 though by a relatively
minimal 0.8%, on a fourth quarter-over-fourth
quarter basis. However, this weakness was not
solely due to the exchange rate as it was also
downwardly affected by a number of the other
negative shocks that occurred last year. As
well, export volumes do not typically respond
immediately to changes in the exchange rate
with the complete effect taking as long as six
quarters to occur. Thus, as discussed in last
year’s Outlook 2004, the rapid appreciation of
the Canadian dollar was expected to have a
more significant dampening impact on growth
in 2004.
Exports recover in the first half of 2004…
With export data available for the first two
quarters of 2004, indications to date of
weakness have been surprisingly muted. The
year-over-year growth has, in fact, risen to
8.5% in Q2. The unexpected strength in
exports was an important factor sending overall
Q2 GDP growth up 4.3% compared to 3.0% in
Q1. Some of the strength in exports may in
part reflect the reversal of the various other
negative shocks that occurred in 2003. As well,
with the US domestic economy growing
between 3½% and 4% over the first two
2003 2004 2005
Annual Average
Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 2003 2004 2005 2006
GDP (q/q % change ann.) 3.3 3.0 4.3 3.3 3.2 3.4 3.6 3.7 3.5
GDP (y/y % change) 1.7 1.7 3.0 3.5 3.4 3.5 3.4 3.5 3.5 2.0 2.9 3.5 3.5
CPI (y/y % change) 1.7 0.9 2.2 2.1 1.9 1.8 1.4 1.2 1.1 2.8 1.8 1.4 1.4
CPI BoC core (y/y % change) 1.9 1.3 1.7 1.8 1.3 1.4 1.4 1.4 1.5 2.2 1.5 1.4 1.7
Unemployment rate 7.5 7.4 7.3 7.2 7.1 7.1 7.1 7.0 7.0 7.6 7.3 7.1 7.0
Overnight rate 2.75 2.47 2.03 2.08 2.50 3.00 3.25 3.30 3.50 2.93 2.27 3.26 4.25
3-month BA 2.72 2.32 2.07 2.22 2.75 3.25 3.50 3.55 3.75 2.97 2.35 3.51 4.45
3-month t-bill 2.65 2.21 1.98 2.15 2.55 3.00 3.25 3.30 3.50 2.86 2.22 3.26 4.25
3-month spread with US 1.73 1.29 0.90 0.66 0.55 0.40 0.50 0.55 0.40 1.85 0.85 0.46 0.15
10-year government bond 4.80 4.44 4.77 4.66 4.85 5.10 5.30 5.35 5.50 4.81 4.70 5.31 5.78
10-year spread with US 0.51 0.42 0.17 0.36 0.15 0.10 0.10 -0.05 0.00 0.80 0.30 0.04 0.05
30-year government bond 5.32 5.09 5.33 5.16 5.20 5.30 5.50 5.55 5.70 5.35 5.20 5.51 5.98
10-year less 3-month t-bill 2.15 2.23 2.79 2.51 2.30 2.10 2.05 2.05 2.00 1.96 2.46 2.05 1.53
C$/US$ 1.309 1.319 1.360 1.308 1.290 1.300 1.290 1.280 1.280 1.400 1.319 1.288 1.271
US$/C$ 0.764 0.758 0.735 0.765 0.775 0.769 0.775 0.781 0.781 0.716 0.758 0.777 0.787
Historical data Forecast data

10
In 2004, exports recovered from various shocks...
Exports
Y/Y% Change
20.0
15.0
10.0
5.0
0.0
-5.0
-10.0
-15.0
Jan-02
...and low interest rates boosted household spending...
Consumer Spending
Y/Y% Change
4.0
3.0
2.0
1.0
0.0
2002:Q1
Jul-02
Q3
Jan-03
2003:Q1
Jul-03
Q3
Jan-04
2004:Q2
Jul-04
...and business investment.
Manufacturing Shipments
Y/Y% Change
15.0
12.0
9.0
6.0
3.0
0.0
-3.0
-6.0
-9.0
Jan-02
Housing Starts
Thousands of units, Annualized
260.0
240.0
220.0
200.0
180.0
Jul-02
160.0
Jan-02 Jul-02
Jan-03
Jan-03
Jul-03
Jul-03
Jan-04
Jan-04
Jul-04
Jul-04
quarters of 2004, Canadian firms have
benefited from solid demand from their
main export market.
…though not likely to be sustained
Looking ahead to the second half of 2004
year, given the lagged impact of the
exchange rate historically on exports, we
expect less robust growth. This will be
the main factor sending the quarterly
GDP growth rate back down to 3¼% over
the last two quarters of 2004.
Investment to take up some of the
slack
Despite this weakening, the expected
overall growth rate remains relatively
robust. This reflects a number of factors.
Though the Bank of Canada started to
push interest rates higher in September,
real rates remain historically low. This is
expected to keep household spending
solid and contribute to sending business
investment on a strong upward trend.
The strength in the latter is will also likely
be abetted by high commodity prices and
an attendant boost to profits. Both
energy and non-energy commodity prices
are supported by strong global demand,
particularly in China and the US.
Business Fixed Investment
Y/Y% Change
6.0
4.0
2.0
0.0
-2.0
-4.0
-6.0
2002:Q1
Q3
2003:Q1
Q3
2004:Q1
Growth in 2004 will double that of 2003
For 2004 as a whole, these various
trends will send GDP up 3.4% on a fourth
quarter-over-fourth quarter basis. This
would represent a doubling of growth
relative to 2003. However, it would also
be about one-half of a percentage point
below the comparable US growth rate.
As suggested a year ago in Outlook
2004, this under-performance is
expected to be largely the result of the
strong Canadian dollar.
In 2005, exports will be limited by the
high Canadian dollar...
The restraining effect on exports from the
strong Canadian dollar is expected to

11
In 2005, the high C$ will restrain exports...
Exchange Rate
US$/C$
0.80
0.75
continue into 2005, albeit diminish as the
year progresses. The negative impact on
exports will be tempered by a US
economy continuing to grow at a solid
pace. In contrast, the restraining effect
from rising interest rates is expected to
intensify moving through 2005. This will
mainly affect interest rate-sensitive areas
of the economy such as residential
investment and consumption of durables.
0.70
0.65
0.60
Jan-02
...while households will face rising interest rates.
Overnight Rate
%
5.0
4.0
3.0
2.0
1.0
2003:Q1
2004:Q1
Jul-02
2005:Q1
FORECAST
2006:Q1
Jan-03
Jul-03
4.0
2003:Q1
Jan-04
10-year GoC Bond Yield
%
6.0
Jul-04
Higher profits and utilization rates will boost investment.
Corporation Profits Before Taxes
Y/Y% Change
35.0
25.0
15.0
5.0
-5.0
-15.0
-25.0
-35.0
2001:Q1
2002:Q1
2003:Q1
2004:Q1
5.5
5.0
4.5
85
84
83
82
81
80
2001:Q1
2004:Q1
Capacity Utilization
Level
2002:Q1
2005:Q1
FORECAST
2003:Q1
2006:Q1
2004:Q1
Despite the rise in interest rates and
attendant weakening in consumption of
durables, monetary conditions will remain
sufficiently stimulative that overall growth
in consumer activity will continue to
expand at a solid 3.0%. This will,
however, be down from the 3.7% pace
expected in 2004.
…though investment will again
provide an offset
Rising interest rates will also be a
restraining factor on business fixed
investment. However, this effect is
expected to be more than offset by other
factors. Commodity prices are expected
to remain high keeping profitability
strong. As well, solid domestic demand
since the 2000-01 slowdown, and
attendant rise in capacity utilization rates,
should encourage businesses to
undertake even greater capital
expenditure next year. As a result,
business investment is expected to
continue to trend higher and thus take a
greater role leading the expansion in
2005.
Our assumption for oil prices is that they
will moderate from recent peaks, though
remain high and average US$36/barrel in
2005. This represents an upward
revision from the US$28/barrel we were
expecting as recently as July. However,
this upward revision is expected to exert
only a small dampening impact on

12
Growth will be sufficient to lower unemployment...
Gross Domestic Product
Y/Y% Change
5.0
4.0
3.0
2.0
1.0
0.0
2002:Q1
...but some slack will remain, keeping inflation in check...
3.5
2004:Q1
Core Consumer Price Index
Y/Y% Change
FORECAST
2006:Q1
Unemployment Rate
%
8.0
7.5
7.0
Non-inflationary rate
FORECAST
6.5
2002:Q1 2003:Q1 2004:Q1 2005:Q1 2006:Q1
growth. In fact, because Canada is a
small net exporter of oil, it has been
argued that higher oil prices should be a
net positive for the Canadian economy.
Certainly our optimism about investment
spending in 2005 is, in part, a reflection
of high energy prices prompting
increased spending in the sector.
However, this will be outweighed by both
the higher energy costs faced by
Canadian producers and the
unambiguously negative effect the shock
will have on US growth and thus
Canadian exports. Of greater
significance to the Canadian economy is
the differing regional impacts between
the oil-producing provinces (e.g. Alberta
and Saskatchewan) and the oilconsuming
regions (notably Ontario and
Québec).
3.0
2.5
2.0
1.5
1.0
2002:Q1
...and the pace of monetary tightening gradual.
Overnight Rate
%
5.0
4.0
3.0
2.0
1.0
2003:Q1
Q3
2003:Q1
2004:Q1
Q3
2004:Q1
2005:Q1
Bank of Canada Target
2005:Q1
Q3
FORECAST
FORECAST
2006:Q1
2006:Q1
Q3
Canada to match US GDP growth…
In total, GDP growth for 2005 is expected
to be fairly close to its 2004 rate, rising
3.5% on a fourth quarter-over-fourth
quarter basis. As well, this pace will be
virtually identical to the 3.6% growth rate
expected in the US. This is the result of
diminishing restraint in Canada from the
strong currency and the dampening
effect in the US of high oil prices.
…and US productivity gains
Projected economic growth in 2004 and
2005 will be slightly above the economy’s
long-run potential. However, we
anticipate that firms will increasingly
attempt to respond to demand by raising
labour productivity growth rather than
taking on more workers. Thus after
lagging the performance in the US since
2000, productivity in Canada is expected
to start to match the US performance in
2005.
Modest tightening in labour markets…
The improvement in productivity will
come at the expense of slowing

13
Though rates will rise in both Canada and the US...
Canada and US Overnight Rates
%
5.0
FORECAST
4.0
employment growth rate which is
expected to be 1.3% in 2004 compared
to an annual average of 1.9% since the
2000/01 slowdown. This in turn will
minimize the improvement in the
unemployment rate projected to be 7.0%
at the end of 2005, little changed from
the 7.1% forecast for the end of 2004.
3.0
2.0
1.0
0.0
2003:Q1
Q3
...a superior Canadian trade performance...
Current Account Balance
% of GDP
5.0
3.0
1.0
-1.0
-3.0
-5.0
-7.0
2000:Q1
2002:Q1
...will provide underlying support to the C$.
Exchange Rate
US$/C$
0.80
0.76
0.72
0.68
0.64
US
0.60
2003:Q1
Canada
Q3
Canada
US
2004:Q1
2004:Q1
2004:Q1
Q3
FORECAST
2006:Q1
Q3
2005:Q1
-10.0
-20.0
-30.0
-40.0
Q3
2006:Q1
Net External Indebtedness
% of GDP
0.0
Q3
-50.0
1991 1993 1995 1997 1999 2001 2003 2005
2005:Q1
Q3
US
Canada
FORECAST
2006:Q1
Q3
FCT
…with unemployment down modestly
With the unemployment rate still slightly
above a so-called “inflation-safe” range of
6.8% to 7.0% for much of the forecast,
labour markets will continue to exert
some, albeit limited, downward pressure
on inflation. This, in conjunction with the
expected rise in productivity and the
earlier appreciation of the Canadian
dollar, will moderate the rise in core
inflation back to the Bank of Canada’s
mid-point target of 2%. This target is
expected to anchor inflationary
expectations through the forecast period.
Monetary policy to tighten gradually…
Interest rates for most of this year have
remained highly accommodative to
ensure that the economic recovery is
sustained. With clear indications by
September that such was the case, the
Bank of Canada started to unwind this
stimulus raising the overnight rate by 25
basis points to 2.25%. Tightening should
continue over the next eighteen months.
The higher rates are intended to keep the
rate of expansion sustainable and the
rate of inflation low. The lack of current
price pressure will, however, allow the
Bank of Canada to maintain a moderate
pace of tightening. We expect the
overnight rate to finish 2004 at 2.75%, to
end 2005 at 3.50%, and to achieve a
near-term peak in mid-2006 at 4.50%.
…sending market interest rates higher
Expectations of tightening policy will
pressure long-bond yields higher through

14
Canada GDP Detail
2003 2004 2005
Q4/Q4 % Change
GDP 1.7 3.4 3.5
Consumer expenditure 2.8 3.7 3.0
Government expenditure 4.0 2.7 2.6
Residential construction 8.3 6.9 -2.3
Business investment 6.0 5.2 8.4
Non-res. Construction 4.9 1.2 4.6
Machinery & equipment 6.7 7.3 10.6
Final domestic demand 3.8 3.7 3.3
Imports 5.0 7.6 4.4
Exports -0.8 8.6 3.7
Levels- Annual (A), Q4 (Q)
Ch. in inventories (97C$bn,Q) 12.2 2.0 6.1
Housing starts (000s,A) 220 222 190
Current account bal. (C$bn,A) 23.8 35.0 26.5
the forecast. For example, yields on 10-year
Government of Canada bonds are expected to
rise from 4.70% currently to 5.50% by the end
of 2005 and a near-term peak of 5.80% by the
spring of 2006. However, this upward trend will
be more moderate than that expected for shortterm
interest rates. Thus there will be a
flattening of the yield curve through the forecast
period.
Further gains are expected in later years as
concern emerges about the large US trade
imbalance.
Risks are generally balanced
The risks to this outlook are generally
balanced. A weaker US growth profile, which
could emerge in the absence of a sustained
uptick in investment and employment, would
mean a less robust pace of activity in Canada
and thus less reason to start pushing interest
rates higher. Another downside risk to growth
is a further marked appreciation of the
Canadian dollar. Such could occur in the wake
of foreign exchange markets showing more
immediate concern about the US trade
imbalance. The main upside risk is that the
impact of the appreciation of the Canadian
dollar has already largely occurred. A more
rapid pace of growth would entail a more
aggressive tightening by the Bank of Canada.
Paul Ferley, Assistant Chief Economist
416-867-7842
paul.ferley@bmo.com
Better trade performance will support C$
Through September, the Canadian dollar has
benefited from a generally weak US currency
appreciating to US$0.790/C$ by the end of that
month. This pressure on the greenback
emerged out of concern about the sustainability
of the US recovery. This trend has been
abetted by rising commodity prices supporting
the loonie. As our forecast of a solid US
recovery and attendant Fed tightening is
realized, we would expect this strength to
initially reverse sending the loonie back down
to US$0.775/C$ by the end of this year.
However, as we move into 2005, a slightly
more aggressive tightening by the Bank of
Canada relative to the Fed will provide some
modest underlying support to the Canadian
dollar. This will send the Canadian dollar back
up to US$0.781/C$ by the end of 2005.

15
Canada’s Regional Outlook
After squeaking by 2003 in the face of much
adversity, most provinces have recovered
nicely in 2004, and growth should strengthen
further in 2005.
Considering the number and magnitude of
shocks that hit the Canadian economy in 2003
– severe acute respiratory syndrome (SARS),
bovine spongiform encephalopathy (BSE), the
stronger Canadian dollar, massive forest fires
in the west, a hurricane in the Maritimes, a
power blackout in Ontario – it is remarkable
that overall growth came in as high as it did, at
2.0%. The confluence of these hits caused
most provinces to record slower growth in 2003
than in 2002.
The weakest growth in 2003 was in Nova
Scotia, which saw natural gas production and
manufacturing activity decline. Ontario was
second weakest as the economic damage from
SARS was concentrated there and the strong
Canadian dollar took its toll on the
manufacturing base. The fastest growth in
2003 came in Newfoundland and Labrador,
which grew 6.5% thanks to a steep increase in
oil production as the Terra Nova oil field came
on stream. Saskatchewan posted the second
fastest provincial growth, with its two-year
drought coming to an end.
With most situations returning to normal in
2004, provincial economic performances have
The Canadian Regional Forecast
Real GDP
Employment
% change % change
2003 2004 2005 2006 2003 2004 2005 2006 2003 2004 2005 2006
Nfld. & Labrador 6.5 1.7 1.2 5.0 1.5 1.8 0.3 1.0 16.8 16.3 16.5 16.2
PEI 1.9 1.5 2.0 3.0 2.6 0.3 0.8 1.0 11.0 11.6 11.6 11.5
Nova Scotia 0.9 2.1 3.0 2.8 1.7 2.4 1.0 0.7 9.3 8.9 8.8 8.8
New Brunswick 2.6 3.0 3.0 2.8 -0.2 2.4 1.2 0.5 10.6 10.2 10.0 9.9
Québec 1.6 2.7 3.5 3.3 1.6 1.7 1.3 1.1 9.2 8.3 8.1 8.0
Ontario 1.3 2.6 3.5 3.7 2.7 1.7 1.3 1.2 6.9 6.9 6.7 6.5
Manitoba 1.4 3.0 3.0 2.8 0.3 1.1 0.8 0.5 5.0 5.2 5.1 5.1
Saskatchewan 4.5 3.0 2.5 2.3 1.0 0.4 0.5 0.5 5.6 5.5 5.4 5.2
Alberta 2.2 4.0 4.0 3.7 2.9 2.0 1.8 1.6 5.1 4.7 4.7 4.7
British Columbia 2.2 3.1 3.5 3.2 2.5 2.0 1.6 1.2 8.1 7.7 7.5 7.4
Canada 2.0 2.9 3.5 3.5 2.2 1.7 1.3 1.1 7.6 7.3 7.1 7.0
Housing Starts
000 units
Retail Sales
% change
Unemployment Rate
%
Consumer Prices
% change
2003 2004 2005 2006 2003 2004 2005 2006 2003 2004 2005 2006
Nfld. & Labrador 2.5 2.9 2.3 2.0 5.8 -1.3 1.1 4.8 2.9 1.9 1.4 1.2
PEI 0.8 0.9 0.7 0.6 0.9 -1.6 0.3 4.6 3.5 2.0 1.2 1.1
Nova Scotia 6.1 4.8 4.7 4.6 1.5 2.4 4.0 4.2 3.4 1.8 1.3 1.2
New Brunswick 4.4 3.5 3.2 3.0 0.1 0.7 3.2 4.2 3.4 1.4 1.1 1.1
Québec 50.7 55.5 42.5 33.0 5.1 4.3 5.2 5.0 2.5 1.7 1.3 1.3
Ontario 85.3 80.4 70.7 64.9 3.4 2.2 4.7 5.2 2.7 1.8 1.3 1.4
Manitoba 4.1 4.4 3.6 3.1 3.6 7.9 5.4 4.9 1.8 2.0 1.4 1.3
Saskatchewan 3.3 3.4 3.0 2.8 5.0 4.4 4.8 5.0 2.3 2.1 1.3 1.1
Alberta 36.5 33.7 31.0 27.0 4.5 11.1 7.2 6.8 4.4 1.5 1.8 1.9
British Columbia 26.1 32.5 28.3 24.0 2.6 6.9 5.9 5.0 2.2 2.1 1.7 1.6
Canada 220 222 190 165 3.8 4.5 5.2 5.3 2.8 1.8 1.4 1.4

16
improved. Sky-high oil prices will push Alberta
back up to its customary spot at or near the top
of the growth rankings. A rebound in
manufacturing has fostered a moderate
improvement in Ontario and Québec despite
the earlier rise in the Canadian dollar. British
Columbia’s economy has benefited from a
booming housing market in the United States –
which has boosted demand for BC wood
products – and an improvement in tourism
activity. Strengthening consumer spending and
robust construction activity are supporting the
Nova Scotia and New Brunswick economies.
The manufacturing, construction and utility
sectors are providing a lift to Manitoba’s
economy.
Only Newfoundland and Labrador, Prince
Edward Island, and Saskatchewan are
estimated to record lower growth this year than
last. In Newfoundland and Labrador, flat oil
production, strikes, and public sector restraint
are taking their toll on the economy. Prince
Edward Island is suffering from low potato
prices, a decline in tourism, and government
spending restraint. Saskatchewan should
record moderate growth in 2004, but below
2003’s unusually strong rebound from drought
conditions during the preceding two years.
In 2005, growth should be about the same or a
little higher than in 2004 in most provinces.
Though commodity prices are expected to
decline from their recent peaks, prices should
still remain high enough to encourage
investment and production in resource-based
sectors. Most provinces will grow close to
potential, as their recoveries gain momentum
and become more balanced. Two exceptions
are likely to be Prince Edward Island and
Newfoundland and Labrador. We do not
expect a significant improvement in Prince
Edward Island’s weak tourism and agricultural
sectors until next summer, which will delay a
full recovery until 2006. Stronger expansion in
Newfoundland awaits the start of production at
the White Rose offshore oil project and the
Voisey’s Bay nickel development, both in 2006.
Newfoundland and Labrador
After cruising along at a breakneck pace in
2003, Newfoundland and Labrador’s economy
appears to have hit a bit of a rough patch in
2004, one that is likely to continue through
2005. GDP growth is expected to slow from
6.5% in 2003 to 1.7% in 2004 and 1.2% in
2005.
The spectacular growth in 2002 and 2003 was
largely due to increased oil production, as
output at the Hibernia offshore oil field
increased and the Terra Nova oil field came on
line. However, oil production has since
flattened out, reflecting the fact that Hibernia
and Terra Nova are reaching full production.
Oil production in 2004 and 2005 should be
similar to 2003. By late 2005 or early 2006, the
White Rose offshore oil project is expected to
produce first oil, resulting in a substantial jump
in production in 2006.
Mining output, about 90% of which is iron ore,
was expected to be a bright spot in 2004.
However, ongoing strikes at the province’s two
large mines in Labrador have reduced output.
The resolution of these labour disputes should
result in an improvement in production in 2005,
while the start of production at the Voisey’s Bay
nickel mine will add substantially to mining
output in 2006.
After a strong increase in 2003, retail sales so
far in 2004 have been weak. Recent strikes in
the public sector and mining industries, as well
as government restraint, appear to have
dampened consumer spending power and
confidence.
One of the few bright spots in 2004 is
construction activity, bolstered by development
of the White Rose offshore oil project and the
Voisey’s Bay nickel mine. However, the
construction phase of these projects will wind
down in 2005. On the residential side, housing
starts are projected to reach 2,900 units in
2004, the highest level since 1991.
Nonetheless, starts peaked in February and

17
have been trending downward since. Housing
starts are expected to fall to a still relatively
high 2,300 units in 2005, as slower economic
growth and rising interest rates take their toll.
Fiscal policy also contributed to the slowdown
in the Newfoundland economy in 2004, and will
continue to do so in 2005. With its 2004
budget, the government implemented a plan to
rein in the province’s burgeoning deficit, with a
planned reduction in the consolidated deficit to
$840 million in 2004-05 from an estimated
$959 million in 2003-04. The 2003-04
consolidated deficit represents about 5.3% of
GDP, making it one of the largest provincial
deficits, relative to the size of its economy, in
Canadian history. The plan includes cutting
about 4,000 of 32,000 civil service positions
over the next four years and implementing a
freeze on public sector wages for two years.
The budget plan calls for the cash deficit to be
eliminated over four years. This would still
leave the consolidated deficit in the $400 -
$500 million range.
Despite the weaker economic conditions,
employment held up rather well in 2004 and is
projected to rise 1.8% for the year. Gains are
likely to be much weaker in 2005, with an
accompanying rise in the jobless rate, as the
economy slows further.
Provincial Government Finances
% of GDP Fiscal Balance Net debt
2003-04 2004-05 Mar.31/04
Newfoundland and Labrador -5.3 -4.7 58.7
Prince Edward Island -2.2 -0.8 32.7
Nova Scotia 0.1 0.0 42.8
New Brunswick -0.6 0.0 30.6
Québec -0.1 0.0 38.1
Ontario -1.1 -0.4 28.1
Manitoba -1.4 -0.1 26.9
Saskatchewan -0.4 -0.8 25.3
Alberta 2.3 1.6 -6.2
British Columbia -0.9 0.6 19.1
Longer-term prospects are better. White Rose
and Voisey’s Bay are expected to go into
production in 2006 (possibly late 2005). There
is the possibility of further offshore oil field
projects and development of the Lower
Churchill hydroelectric resources in later years.
Prince Edward Island
Prince Edward Island’s economy appears to
have slowed in 2004 to a 1.5% pace from 1.9%
growth in 2003.
Many economic indicators are pointing
downward so far in 2004. Farm cash receipts
have dropped sharply, largely due to weak
potato prices. Employment has essentially
been flat since the beginning of the year. Retail
sales have been barely treading water and look
poised to sink for the year as a whole. While
manufacturing shipments showed strength
earlier in the year, they have since softened.
And, most tourism indicators are down from the
same period a year earlier.
One bright spot is construction. Housing starts
appear set to hit 900 in 2004, the highest level
since 1988. We expect rising interest rates to
push starts down to 700 in 2005, but this would
still be a relatively high level. On the nonresidential
side, construction is benefiting from
a boom in public sector building.
Fiscal policy has contributed to soft economic
conditions in the province. Following a 2003-
04 deficit estimated at $85 million, or 2.2% of
GDP, the government increased gasoline taxes,
tobacco taxes, capital taxes on financial
corporations, and a number of fees. Program
spending was cut 3.6%. For 2004-05, the
deficit is budgeted to fall to $33 million. Further
fiscal restraint will be required in 2005-06 in
order to eliminate the deficit.
Our forecast of 2.0% GDP growth in 2005 is
based on a gradual improvement in tourism
and a return to better agricultural market
conditions.

18
Oil production takes a breather in Newfoundland.
Newfoundland Oil Production
Millions of barrels, annual
150
FORECAST
Nova Scotia
After posting the lowest growth rate
among the provinces in 2003, Nova
Scotia’s economy has picked up in 2004
and should strengthen further in 2005.
We project real GDP growth of 2.1% in
2004 and 3.0% in 2005.
120
90
60
30
0
Natural gas production declining gradually in Nova Scotia.
Nova Scotia Natural Gas Production
Millions of cubic metres per month
New Brunswick's employment picture brightens.
New Brunswick Employment
% Change
3.5
3.0
2.5
600
500
400
300
200
100
1997
0
2000
1999
2001
2001
2002
2003
2003
2005
2004
FORECAST
In 2004, signs of improvement have been
evident, although a few negatives still
cast a shadow on the province’s
economic performance. Housing starts,
which reached a 16-year high of 6,100
units in 2003, have fallen to about a
4,800 pace in 2004, in part due to a
moratorium until late 2005 on large
housing developments in some areas of
Halifax. Natural gas production was
down in the first eight months of 2004, as
output from the Sable Offshore Energy
Project weakened. Further, recent
disappointing drilling results slowed
offshore energy exploration activity.
However, the positives outweighed the
negatives. Employment, manufacturing
shipments, and the value of building
permits showed good gains through the
summer. Consumers have also jumped
on board the expansion train. After
almost stalling in 2003, retail sales have
accelerated sharply since the beginning
of 2004. These economic indicators
suggest considerable momentum going
into 2005.
2.0
1.5
1.0
0.5
0.0
-0.5
2000
2001
2002
2003
2004
Nova Scotia’s economy is also benefiting
from the fact that it is the only Atlantic
province not undergoing significant fiscal
restraint. Nova Scotia was one of only
two provinces to run surpluses in the
2003-04 fiscal year. In its 2004-05
budget, the government cancelled part of
a previously implemented 10% personal
income tax cut, implemented a higher tax
rate on high-income earners, raised the
tobacco tax and the corporate capital tax,
and increased a number of government

19
fees and fines. Despite rising taxes, the fiscal
stance is considered roughly neutral as the
additional revenues funded a hefty 5.4%
increase in program spending. We expect the
fiscal stance in 2005-06 to remain neutral.
Going forward, Nova Scotia’s economy will
benefit from solid growth in North America,
which should boost demand for its goods and
services. It will also be stimulated by a number
of specific projects, including the ongoing
cleanup of Halifax harbour and the Sydney tar
ponds. Tier II of the Sable Offshore Energy
Project should come on stream in late 2004,
boosting natural gas production. Possible
development of the Deep Panuke offshore
natural gas project (the current status appears
to be in limbo) and a possible liquid natural gas
terminal on Cape Breton Island would further
boost economic activity.
New Brunswick
After encountering a number of economic
challenges in 2003, the New Brunswick
economy has had a relatively smoother ride in
2004.
Economic indicators in 2004 point to somewhat
stronger growth of 3.0% this year, up from
2.6% in 2003. After a decline last year,
vigorous export growth has resumed. Job
creation has picked up smartly. The province’s
manufacturers have more than tripled their
pace of growth (as measured by shipments)
through midyear. Though residential
construction activity has moderated from last
year’s peak, it remained relatively robust, with
3,500 new housing units projected in 2004, still
above the past ten-year average.
New Brunswick’s economic performance in
2005 should match that in 2004, with a repeat
expansion rate of 3.0%. We expect
employment growth to continue at a healthy
pace, allowing a slight drop in the
unemployment rate. Employment gains should
give a boost to consumer spending – which has
been quite weak through most of 2004 –
starting later in the year and continuing into
2005. Capital spending is expected to remain
strong, due to the ongoing twinning of the
TransCanada highway and the beginning of
construction of a $750 million liquid natural gas
terminal, which received regulatory approval in
August and is expected to go into operation in
2007. However, on the residential side,
housing starts are projected to moderate
further in 2005, as interest rates rise.
The generally upbeat assessment in the near
term is somewhat tempered by fiscal restrain,
and the unexpected closure of two of the
province’s paper mills in September. The
province’s 2004 budget called for about 750
civil service positions to be eliminated and
program spending to rise only 0.8%. Taxes on
small businesses were reduced, but the
government’s revenue loss was more than
offset by increases in various government
service fees and fines.
The good news is that fiscal restraint should
return the province to a surplus position in the
fiscal year ending in March 2005, which
suggests that there will be less need for
additional restraint in 2005-06.
Québec
Québec’s economy gained momentum in 2004,
after it grew a mere 1.6% in 2003, when
exports dragged down an otherwise positive
performance.
In 2004, while the domestic economy slowed
slightly, the external sector has provided much
stimulus. Any doubts about the export revival
were allayed by an annualized 18% jump in
real exports in the second quarter.
Consumption remains a source of strength,
notwithstanding some slowing midyear.
Consumption should benefit later this year and
next from an improving labour market and the
$1-billion tax cut that comes into effect in 2005.
Employment growth was weak in the first half
of 2004, with what growth there was

20
Québec's manufacturing sector recovers.
Manufacturers' Shipments
$ Billions, monthly seasonally adjusted
12.0
concentrated in the service sector. But
the recovery in exports and
manufacturing should result in
employment gains into 2005. Following
five consecutive quarters of decline up to
the third quarter of 2003, manufacturing
output is growing once again.
11.5
11.0
10.5
10.0
Jan-01
Ontario's prospects brighten after 2003 slowdown.
Real Gross Domestic Product
% Change
6.0
5.0
4.0
Jul-01
Jan-02
Jul-02
Jan-03
Jul-03
FORECAST
Jan-04
Jul-04
Housing starts appear set to reach
55,500 this year – a 16-year high.
However, we expect starts to trend down
to 42,500 next year, as interest rates rise
and housing inventory catches up to
demand. Non-residential construction
should remain strong, boosted by a
number of hydroelectric projects.
Investment in machinery and equipment
should also remain robust, as the strong
Canadian dollar increases the need for
productivity-enhancing improvements
and, at the same time, lowers the
Canadian-dollar price of imported
equipment.
3.0
2.0
1.0
0.0
Manitoba housing starts to hit a 16 year high.
Manitoba Housing Starts
Thousands
6.0
5.0
4.0
3.0
2.0
1.0
0.0
1988
2000
1990
2001
1992
2002
1994
1996
2003
1998
2004
2000
2005
2002
2006
FORECAST
2004 2006
After a small deficit in 2003-04, the 2004-
05 budget, presented in the spring, was
balanced. Whether or not the budget
can, in fact, be balanced remains to be
seen. It was based on the assumption of
significant concessions from public sector
unions, but the government has backed
down on many of those issues. Program
spending was budgeted to rise only 2.9%
in nominal dollars in 2004-05, and 2.6%
in 2005-06. Therefore, if such tight
government expenditure growth is
achieved, it would likely be a drag on
growth over the near term. However, this
would be largely offset by a $5 billion tax
cut over five years, which would stimulate
consumer spending. The first $1 billion
installment of the $5 billion tax cut is
slated to come into effect in 2005.
Overall, Québec’s economy should pick
up, with growth accelerating from 1.6% in
2003 to 2.7% in 2004 and 3.5% in 2005,
based on strong consumer spending,

21
non-residential investment, and export
demand.
Ontario
Ontario’s economy is recovering gradually from
last year’s slowdown, which was induced by
SARS, the stronger Canadian dollar, weak US
demand for Ontario’s exports, and the August
electricity blackout. Ontario suffered a technical
recession in the second and third quarters of
2003, led by a decline in manufacturing and
exports. For 2003 as a whole, growth
measured only 1.3%.
Although the province’s economy got off to a
slow start in 2004, with continued weakness in
manufacturing and falling construction, activity
has since gained momentum. Stronger
markets in the United States have spurred
Ontario’s manufacturing sector. And,
residential construction gained traction
following a weak first quarter.
Employment has continued to rise in Ontario,
although the pace has recently eased over the
past several months. Part of the reason for this
is the strong Canadian dollar, which is forcing
firms to improve productivity in order to meet
rising competition. At the same time, the strong
Canadian dollar is lowering the cost of the
imported machinery and equipment that is
required to boost productivity. The business
sector has responded to competitive
challenges by substantially raising investment
in machinery and equipment.
Ontario consumers have been hesitant, with
retail sales growth very sluggish. The $2.4
billion health care premium, which came into
effect on July 1, will further weigh on consumer
spending going forward. However, we expect
that a continued strong performance by the
service sector and the ongoing recovery of
manufacturing will boost employment and
earnings next year, contributing to a rebound in
consumption expenditure in 2005.
The housing market remained strong in 2004,
though off its 14-year peak in 2003. Housing
starts will likely come in just over 80,000 in
2004, after topping 85,000 in 2003. We expect
a further weakening in 2005 to about 70,000,
as previously pent-up demand for home
ownership has largely been met and as interest
rates rise.
After posting a $0.1 billion surplus in 2002-03,
the Ontario government’s fiscal balance swung
sharply to a deficit of $5.5 billion in 2003-04.
Rather than cut program spending, which is
budgeted to rise 6.7% in 2004-05, the
government implemented a health care
premium of up to $900 per taxpayer (tied to
income) to help reduce the deficit. The health
care premium will raise $1.6 billion in new
revenue in 2004-05 and $2.4 billion in 2005-06.
The government projects that the deficit will fall
to $2.2 billion in 2004-05, but this is mainly due
to a bookkeeping adjustment related to the
restructuring of the province’s electricity sector.
Without this adjustment, and without the $1
billion reserve against unforeseen
contingencies, the underlying budgeted deficit
is $5.1 billion, or little changed from 2003-04.
As such, the 2004-05 budget is relatively
neutral in its impact on the economy. The fiscal
stance will change to restrictive in 2005-06,
when the government plans to reduce the
underlying deficit to $0.6 billion, mainly by
holding growth in program spending to 0.7%.
Overall, we expect Ontario’s economy to grow
2.6% in 2004. As Canadian manufacturers
adjust to the higher currency, through
productivity-enhancing investment and
strategic initiatives, a continued supportive
North American macroeconomic environment
should allow economic growth to improve
further to 3.5% in 2005 and 3.7% in 2006.
Manitoba
After posting only 1.4% growth in 2003,
Manitoba looks set to bounce back to 3.0%
growth in both 2004 and 2005.

22
Residential construction has been robust in
Manitoba recently, with housing starts
estimated to hit 4,400 in 2004 – the highest
level in 16 years. Starts are projected to taper
off in 2005 but remain relatively high at 3,600
units. Non-residential construction should be
supported in 2005 by a number of large
projects, including the $660 million expansion
of the Red River Floodway.
After a poor performance in 2003, we expect
the manufacturing sector to make substantial
gains in 2004 and 2005. In particular, the
province’s two largest manufacturing export
categories (food and transportation equipment)
are set for strong growth. Food processing
should grow smartly, thanks to continued
improvements in agricultural production and
relatively strong US demand. Transportation
equipment manufacturing (mostly airplanes and
buses) should improve as the North American
travel outlook brightens and many US cities
upgrade their bus fleets.
Agricultural prospects also look encouraging as
soil moisture conditions have continued to
improve following the 2001-02 drought.
Reflecting higher prices, farm cash receipts
have risen solidly in 2004. Our forecast
assumes average crop yields in both 2004 and
2005.
Hydroelectric production has rebounded in
2004, after low water levels reduced output in
2003. Water flows are now above normal,
which will result in ongoing strength in hydro
sales. Longer term, the outlook for hydro looks
bright. The province is examining a number of
hydroelectric developments that would result in
increased sales to Ontario and Saskatchewan.
Public sector restraint will weigh on the
economy this year and next. On a
consolidated basis, the 2003-04 deficit hit $531
million, largely due to the poor performance of
Manitoba Hydro, which in turn was a result of
the low water flows mentioned earlier. For
2004-05, the government budgeted for the
deficit to fall to $58 million, thanks to fiscal
restraint and an expected improvement at
Manitoba Hydro. Four hundred civil service
positions will be cut and base program
spending is to rise only 1.4%. While program
spending is budgeted to rise at a somewhat
faster pace in 2005-06 (2.6%), it would remain
well below the rate of nominal GDP growth.
Labour market conditions have been rather
tepid in 2004, with sluggish employment and a
modest upward tilt to the jobless rate.
Nevertheless, at a projected 5.2% for 2004 as
a whole, the jobless rate in Manitoba would be
second lowest in Canada, after that in Alberta.
Labour earnings growth has been far better
than in Canada as a whole, providing solid
support for consumer spending. Retail sales
are projected to rise by close to 8% in 2004,
almost double the national rate and second
fastest after Alberta. In 2005, continued solid
growth in employment should reduce the
unemployment rate even further to 5.1%.
Saskatchewan
Saskatchewan posted a healthy increase in
GDP of 4.5% in 2003, thanks to the end of a
two-year drought that had caused crop
production to plummet between 2000 and
2002. Crop output rose substantially (46%) in
2003 to 21.8 million tones, though it remained
below its ten-year average of 23.7 million
tonnes.
Good soil moisture conditions early in the 2004
growing season fostered hopes for a bumper
crop this year. Unfortunately, cool, wet weather
late in the summer and, in some places, early
frost, dashed such expectations.
Saskatchewan Agriculture’s latest crop
production estimate (September 27th) pegged
2004 production at 25 million tones. While
production is above average in quantity, it is
likely be below average in terms of quality.

23
The mining and oil and gas sectors are doing
well. Potash production and prices are well
above last year’s levels as a result of strong
global demand. Uranium mining is also
benefiting from firm demand and high prices.
Mineral fuels exploration, development, and
extraction continue to be strong, due to skyhigh
energy prices. Oil production has been
virtually flat recently but gas production has
registered solid gains.
Manufacturing has been another source of
strength, with healthy gains in food processing
and petroleum and coal products.
While running a little below the previous year’s
pace on an annualized basis, retail sales have
recently strengthened and should remain solid
in 2005. We expect the contribution of
consumer spending to Saskatchewan’s
economic expansion to increase in 2005 as
retail sales growth rises to 4.8%.
Construction activity is likely to weigh on the
province’s economy next year. Housing starts
are poised to hit 3,400 in 2004 and then slip to
3,000 units in 2005 as interest rates rise. On
the non-residential side, a substantial decrease
in the value of building permits issued suggests
softer conditions ahead in that segment of the
market.
Public sector restraint will also be a drag on
growth. In order to keep the deficit under
control, the government increased the
provincial sales tax by one percentage point in
its spring budget, cut 500 civil service positions,
and held program spending to a 0.9% increase
in 2004-05. Despite these measures, the
deficit is still expected to rise from $147 million
in 2003-04 to $287 million in 2004-05. In 2005-
06, program spending is slated to rise only
1.1%.
All told, healthy conditions for agriculture,
mining, oil and gas, and manufacturing should
lift economic growth in Saskatchewan to 3.0%
in 2004. An assumed return to average crop
yields and a weakening of oil, gas and potash
prices is expected to moderate growth to 2.5%
in 2005.
Alberta
With oil prices rising above US$50 a barrel, it’s
a great time to live in Alberta. Alberta should
lead the country in economic expansion this
year and next, with growth of 4.0% in each
year.
Almost all economic indicators are pointing
upward. Employment has continued to rise at
a brisk pace, with strong gains in construction,
mineral mining, and oil and gas extraction.
Exports, manufacturing shipments, and retail
sales have all been rising by more than 10%.
And, wage gains have been amongst the
strongest in the country. Only the housing
market is looking at declines this year. After
topping 36,000 units in 2003, housing starts are
projected to decline to just under 34,000 in
2004.
Even the agricultural sector is showing
strength, despite the ban on live cattle exports
to the United States. Farm cash receipts are
up by more than 8%, with gains for grains,
oilseeds, hogs and poultry more than offsetting
losses by cattle operations.
In 2005, high energy prices, though off their
2004 peaks, should sustain construction and oil
and gas sector activity. The Alberta
government’s inventory of major projects
currently under construction, proposed, or
recently completed lists 1,047 projects with a
value totaling $94 billion in September (up 16%
from a year earlier). Two-thirds of these
projects, by value, are in the oil and gas sector.
Manufacturing should also continue to do well,
with healthy gains by food processors, metal
fabricators, and manufacturers of wood
products, computers and electronics, and
machinery and equipment.

24
Saskatchewan recovers from 2001-02 drought.
Crop Production
Millions of tonnes
30.0
25.0
20.0
15.0
10.0
5.0
0.0
Alberta booms as oil prices skyrocket.
Oil Prices
WTI, US$/bbl
55.0
45.0
35.0
25.0
15.0
5.0
Jan-02
Stronger lumber exports boost BC's economy.
British Columbia Wood Product Exports
C$ millions, monthly
1000
800
2000
Jul-02
2001
Jan-03
2002
Jul-03
2003
Jan-04
FORECAST
2004
Jul-04
Oil and gas royalty revenues are rolling in
for the government. In its spring budget,
the government assumed that oil prices
would average US$26.00/bbl during the
2004-05 fiscal year, and natural gas
prices C$4.20/mcf. In its first-quarter
update, the government increased these
forecasts to US$34.00/bbl and C$6.01/
mcf, resulting in an extra $3 billion in
resource revenues. However, even this
appears conservative as oil has so far
averaged more than $41/bbl while natural
gas has averaged C$6.50/mcf. Each
US$1 increase in the price of oil adds
about $65 million to the government’s
coffers, while each 10¢ increase in the
price of natural gas adds $105 million.
The government has used this revenue
windfall to eliminate its gross debt (its net
debt was eliminated by the end of the
2000-01 fiscal year) and increase
spending by $1.4 billion (6.2%), over and
above the 2.6% increase allowed for in
the spring budget. This increase in
expenditures includes an expanded
capital spending program, rebates for
natural gas customers, agricultural
assistance, and health and education
initiatives.
Clearly, expectations for continued
healthy growth in the global economy, a
robust energy sector, and Alberta’s fiscal
strength position the province for strong
medium-term expansion.
600
400
200
0
Jan-03
Jul-03
Jan-04
Jul-04
British Columbia
British Columbia’s economy finally seems
to be hitting its stride after a sub-par
performance over the last 10 years. BC’s
average economic growth rate over the
last ten years was the second lowest
among the provinces. In 2003, BC’s
GDP growth (2.2%) beat the national
average, but only because the national
average was relatively low, at 2.0%. This
year and next, BC’s economic expansion
should approximately match the national

25
average, with growth of 3.1% in 2004 and 3.5%
in 2005.
In the manufacturing sector, the value of
shipments has been bounding ahead, bolstered
by flat-out production of lumber and structural
panels and sharp price increases for those
products. A good part of the jump in
manufacturing shipments has been stimulated
by sales into the US market, where housing
starts have been booming. Additionally, the
nascent upturn in the hi-tech sector has
improved prospects for the province’s
electronics manufacturers.
British Columbia’s construction industry has
provided good support to the economy.
Housing starts hit a seven-year high of about
26,000 in 2003, and looks set to reach 32,500
in 2004. And, the value of non-residential
building permits has also been rising at a brisk
pace, with the gains concentrated in the
commercial and industrial segments. The latter
has largely been stimulated by construction
expenditures related to natural gas
development and transportation and utilities.
Following a 2.5% employment gain in 2003,
BC’s labour market continues to do well.
Sustained robust employment growth should
lower the average jobless rate in 2004 to 7.7%
from 8.1% in 2003. Further declines are
expected during the next two years, with the
jobless rate falling to 7.4% by 2006.
After a modest 2.6% gain in 2003, retail sales
have surged in 2004 and are projected to rise
on average by close to 7%. Sales have been
bolstered by continued strong employment
growth, improving consumer confidence, and a
rebound in tourism following the previous
year’s SARS-induced setbacks.
Looking ahead to 2005, we expect construction
in the province to moderate, as the domestic
housing market eases from its 2004 peak.
Similarly, a slowdown in the housing market in
the United States will dampen the rate of export
growth, which is heavily dependent on lumber
and other forest products. Further, we expect
commodity prices to recede from their recent
lofty levels.
On the plus side, consumer spending is
projected to remain strong. And, the
government is expected to moderately boost
spending now that its budget has been
balanced again. High energy prices are
supporting increased oil and gas exploration
activity. And preparations for the 2010 Winter
Olympics, including associated transportation
infrastructure improvements, should provide a
boost to non-residential construction.
British Columbia’s 2003-04 government deficit
fell to $1.3 billion, some $1 billion better than
budgeted in the spring of 2003. For 2004-05,
the government budgeted for a surplus of $100
million, but has recently updated its projection
to $865 million. The 2004-05 budget called for
program spending to fall 2.4%. Most of these
cuts were in place by early in the fiscal year.
With the budget balanced, government restraint
should no longer be a drag on growth.
As always with the BC economy, there are
many risks to the outlook. The main risks are
the strength of the US economy in general and,
in particular, the housing market and
commodity prices. A resolution of the softwood
lumber dispute with the United States – which
now appears possible – would be an important
plus for the provincial economy.
Earl Sweet, Assistant Chief Economist
416-867-4823
earl.sweet@bmo.com
Robert Hogue, Senior Economist
416-867-5049
robert.hogue@bmo.com
Kenrick Jordan, Senior Economist
416-867-5547
kenrick.jordan@bmo.com

26
World Outlook
Overview – Oil the burning question
World growth will likely be near 5% this year.
This is in large part attributed to the broadbased
monetary easing that took place in
response to the global slowdown of 2001-02.
With the expansion on solid footing, most
central banks have begun to normalize these
extraordinarily easy monetary conditions. The
strength in the Chinese economy has also
been a key factor in sending growth higher in
neighbouring economies, particularly Japan.
Higher interest rates will dampen economic
growth in 2005 as will the sharp rise in oil
prices this year. The price of WTI is currently
more than 50% above last year’s average.
Nevertheless, though slowing, world growth is
still expected to be above 4% in 2005.
The key risk to the global outlook is oil prices.
While prices are expected to fall from current
levels, this outcome is far from certain.
Persistently high or even higher prices would
have a more damaging impact on global
growth.
Euro-zone: Domestic demand still weak
Economic growth in the Euro-zone picked up in
the first half of 2004 rising an annualized 2.2%
– double the rate in the second half of 2003
and a marked improvement over the decline in
the first half of 2003. External demand has
been the driving force of growth this year as net
exports accounted for 60% of GDP growth in
the first half of the year.
The pace is likely to be maintained in the
second half of the year leaving annual average
growth at 2.0%. However, slower growth is
expected in 2005 as global activity loses speed
at a time when domestic demand is still
struggling to gain momentum. To date, firms
have generally been reluctant to add capacity,
though some acceleration in investment is
taking place. However, consumer spending is
still soft as the expansion remains insufficiently
strong to ignite job creation. Employment has
stagnated over the last two years and, as a
result, consumer confidence and spending are
lackluster.
The World Outlook
GDP Growth
Inflation
2003 2004 2005 2006 2003 2004 2005 2006
World 3.8 4.8 4.1 3.8 3.7 3.6 3.1 2.6
North America 2.9 4.2 3.7 3.6 2.3 2.5 1.9 1.8
Western Europe 0.8 2.3 2.0 2.3 2.0 1.9 1.8 1.5
Euro-zone 0.5 2.0 1.8 2.2 2.1 2.1 1.8 1.5
UK 2.3 3.4 2.8 2.5 1.4 1.3 1.7 1.5
Asia-Pacific 6.3 6.6 5.5 5.2 1.7 3.0 2.7 2.8
Japan 2.5 4.3 2.5 2.0 -0.3 -0.2 -0.1 0.1
China 9.4 9.1 7.8 7.5 1.2 4.2 3.4 3.5
Emerging East Asia ex. China 4.3 5.8 4.8 4.6 2.9 3.8 3.9 3.7
Latin America 1.8 5.2 3.8 3.7 11.0 5.9 5.7 5.4

27
While interest rates are still low and stimulative,
fiscal policy is, at best, neutral. Though France
and Germany will probably continue to exceed
the 3%-of-GDP deficit limit imposed by the
Stability and Growth Pact, the overshoot
provides no significant accommodative thrust.
Thus, with only modest domestic growth
expected and export demand slowing, GDP
growth is set to soften slightly in 2005 to 1.8%.
At this pace there is no urgency for monetary
tightening as below-potential growth should
ensure excess capacity and low inflation. The
European Central Bank is not expected to raise
rates until early-to-mid 2005.
UK: A jump on tighter policy will slow
growth
The UK economy is in good shape. Growth is
well above trend – rising nearly 4% year-overyear
in Q2 – unemployment is the lowest in
decades and inflation below target. To ensure
inflation stays low, the Bank of England started
tightening monetary policy almost a year ago.
Since November 2003 interest rates have been
hiked 125 basis points. Further tightening is
expected to take the repo rate back to a neutral
5.25% by early 2005.
Higher interest rates are expected to slow the
economy in the latter half of 2004 and into
2005. In fact, the housing market, in which
prices have doubled over the last five years
and been of key concern to the Bank of
England, appears already to be losing
momentum. Nevertheless, in 2005, the
economy will still be growing above potential.
With little slack left in the economy – the
unemployment rate (ILO basis) has fallen
below 5% – there is likely to be some upward
pressure on inflation, though falling oil prices
will provide an offset.
Japan: Signs of a tentative broadening in
the expansion
The current Japanese expansion is more than
two years old and has proved surprisingly
strong. Growth in first half of the year
averaged 5.4% at an annual rate and will likely
average above 4% in 2004 – the most rapid
since 1990.
Nevertheless, the expansion still remains
predominantly driven by external demand and
by the corporate sector, while the household
sector remains largely on the sidelines. Net
exports, business investment and inventory
accumulation have contributed over 80% of
GDP growth in this recovery.
Successful industrial restructuring has been the
key to the durability of this recovery. Since
the late 1990s companies have reduced costs,
cut excess capacity and lowered corporate
debt. While restructuring has fuelled strong
profit and productivity growth, it has also
dramatically cut employment and wage growth
and consequently consumer spending.
Recently, there have been some signs of a
spillover from corporate profit to wages while
employment has stopped falling and spending
is up.
Looking forward, the upward trend in Japan’s
exports is likely to continue on the back of still
firm global growth especially in the US and
China. And, as long as exports are rising, the
mild recovery in domestic demand should
continue. However, the growth rate of exports
is slowing, suggesting that GDP growth will
likely slip to 2.5% in 2005.
With ample spare capacity and growth moving
closer to trend, the output gap is likely to
narrow only gradually and inflation is expected
to remain negative throughout 2005. Thus,
though a more robust economy will allow the
Bank of Japan to start moving rates above zero
in 2005, the pace will be gradual.
Despite the favourable cyclical developments,
long run obstacles to growth remain. Japan’s
financial system is still weak, with bank lending
continuing to decline and fiscal finances dire –

28
High oil prices...
WTI
US$/bbl
50
40
30
20
10
2001:Q1
...and rising interest rates...
US Fed Funds Rate
%
6.0
5.0
4.0
Q3
2002:Q1
Q3
2003:Q1
Q3
2004:Q1
FORECAST
Q3
the ratio of public debt to GDP is
projected to surpass 160% this year. The
need for fiscal tightening will restrain
economic activity in Japan for many
years.
Emerging Asia: Top of the Cycle
Economic growth in Emerging Asia has
now reached a cyclical peak and should
see a gradual decline through 2005.
Exports drove a strong pick up in growth
in Emerging East Asia last year, with
GDP rising over 8.0% (y/y) by Q4 and in
the first half of this year. However,
weaker external economic conditions will
lower growth going forward. Slower
growth in the main developed economies
combined with China’s efforts to
moderate its lofty expansion will dampen
the region’s fast-paced export activity.
High oil prices will also have an adverse
impact on those Asian economies which
are dependent on energy imports.
3.0
2.0
1.0
0.0
2001:Q1
...will dampen world growth next year.
World GDP
Y/Y% Change
5.0
4.0
3.0
2.0
1.0
0.0
Q3
2001
2002:Q1
2002
Q3
2003:Q1
2003
Q3
2004:Q1
2004
Q3
2005:Q1
FORECAST
2005
Q3
2006
Many Asian countries may also be set for
a period of interest rate increases to
address emerging inflation pressures.
Average inflation in East Asia is expected
to more than double to 4.1% this year.
However, much of the increase has been
due to rising food and fuel prices, which
should abate in the near term. Thus,
though some tightening is required, most
Asian central banks will likely take the
opportunity to ease upward pressure on
their exchange rates by not fully
matching US rate rises. In countries
such as Korea, interest rates may
actually decline further as the
government focuses on reviving
consumption rather than tackling
inflation.
The moderate rise in interest rates, plus
the gradual easing in oil prices, should
help limit East Asia’s economic slowing
next year. Overall regional growth should

29
moderate to 6.7% next year after averaging just
under 8% in 2004.
China is a key risk to the Asian outlook.
Despite the negative impact of SARS last year,
growth was still 9.4% and accelerated to 9.7%
(y/y) in the first half of this year. With inflation
rising rapidly to over 5% and investment
soaring, fears of overheating led the
government to tighten policy in early 2004,
mainly through targeted administrative
measures. Indicators suggest the economy is
headed for a soft landing, but the evidence
remains mixed and further tightening measures
may be needed. Ultimately, a soft landing is
expected, with growth slowing to under 8% in
2005, but the risk of a hard landing would have
a distinctly negative impact on the region.
While uncertainties remain, China is unlikely to
soon alter its currency peg to the US dollar, but
the government’s stated intent of moving to a
more flexible exchange rate may lead to a
modest appreciation in the latter part of 2005 or
in 2006.
Latin America: Solid Recovery
Latin America had only a modest recovery last
year from the economic decline of 2002, with
GDP for the region rising 1.8%. In fact, tight
economic policies produced a marginal GDP
decline in Brazil while political and economic
turmoil led to a massive 9.2% fall in Venezuela.
This year, Latin America is undergoing a much
more robust recovery, with GDP expected to
rise more than 5% — the best result since
1997. Even excluding the anomalous
outperformance of Argentina and Venezuela,
growth will rise 4.5% this year. The region has
been helped by external developments,
including higher commodity prices, healthy US
and Chinese markets and low international
interest rates. Regional growth should subside
as these advantages wane in 2005 and as
economic policies are tightened in response to
emergent inflation pressures.
Brazil’s rebound has been particularly robust.
After falling 0.2% last year, GDP growth will rise
sharply to an expected 4.8% this year. Fiscal
and monetary austerity has firmly established
policy credibility, boosting confidence and
leading to strong growth in domestic demand.
This is being complemented by strong export
growth which is lifting the current account
surplus to around 1.5% of GDP. The strong
growth is raising inflationary pressures leading
the central bank to begin interest rate
increases. Policy tightening and slowing
exports will lower growth next year, but it
should remain healthy at 4.0%.
Mexico has been riding the strength of the US
economy and is expected to see growth of
4.1% this year after only 1.3% last year.
However, as in Brazil, rising inflationary
pressures are leading to monetary policy
tightening. Combining the tighter policies with
the expected slowing of US growth, Mexico’s
GDP growth should moderate next year to
around 3.5%.
Elsewhere, Venezuela’s expected 12.5%
growth this year is due to a politically driven, oil
boom-financed, expansionary fiscal policy.
Growth should moderate sharply in 2005.
Other Andean countries have also benefited
from strong commodity prices, with Chile
expected to register particularly strong growth
of over 5%. Meanwhile, Argentina may register
strong growth of around 7% this year, but the
economy is already clearly slowing and growth
of 3.5% is expected for 2005.
Barney Bonekamp, Senior Economist
416-867-4942
barney.bonekamp@bmo.com
Laurie Peterson, Senior Economist
416-867-4793
laurie.peterson@bmo.com

30
Oil Price Outlook
Supply risk roils oil prices
Oil prices have spiked above the US$50/barrel
mark for US benchmark West Texas
Intermediate (WTI). In current dollar terms, this
is higher than they have ever been.
High oil prices partially reflect rapid growth in
global consumption, particularly in China and
other parts of Asia. Despite a number of
disruptions to supply this year, global
production of oil has more than kept pace with
demand, allowing for a rebuild of inventories
from very low levels at the beginning of the
year. Strong supply growth primarily reflects
continued robust gains in Russia and a
substantial ramping up of production by OPEC.
However, in order to quickly raise output,
OPEC has had to reduce its margin of excess
capacity. This narrowing of OPEC’s cushion to
deal with supply shocks – at a time when
geopolitical and weather-related events have
made such a cushion so important – has
unsettled the global oil market and contributed
to the large risk premium on prices. Thus,
while production is currently adequate to meet
demand and rebuild inventories, high oil prices
reflect the market’s concern about geopolitical
risks to available supply and OPEC’s narrow
margin to deal with risks that actually
materialize.
Looking ahead, some elements of supply risk
are likely to diminish during the next year.
Some have already fallen off the radar screen
and others are likely to follow. Further, markets
do respond to high prices. Both supply and
consumption adjust to changing prices,
although in the oil market this sometimes takes
quite a while. Nevertheless, high prices are
stimulating investment in new oil producing
capacity in OPEC and elsewhere. And, if
sustained, high prices would lead households
and businesses to take steps to reduce
consumption of oil-based products. Newly
emerging risks, such as the possibility of labour
strikes and increasing rebel insurgency in
Nigeria, could push prices even higher during
the next few months, particularly with the
approach of the winter heating season.
However, over the medium- to longer-term, oil
prices are not likely to be sustained at current
levels.
This note examines current oil market
conditions in an historical context and
assesses the likely direction of factors which
have forced prices well above normal.
Oil prices spike well above normal range
Oil prices are at record-high levels in terms of
current dollars. However, adjusted for inflation,
they are well below those prevailing in 1980,
following the revolution in Iran. For instance,
using constant 2004 dollars, oil prices in early
1980 were over US$80/barrel. However,
adjustments on both the demand and supply
sides of the market during the ensuing few
years led to a sharp reduction in oil prices. By
1986, the West Texas Intermediate price fell
back into its ‘normal’ range.
In assessing the equilibrium price for oil and a
normal trading range around that price, oil
markets for 1986-2003 interval were examined.
During that period, the real price of WTI, in
constant 2004 dollars, averaged US$25/barrel.
Its ‘normal’ range, as measured by two
standard deviations on either side of the
average, was US$15-35/barrel during that
period. There have been a few times when
prices moved outside that normal range. At the
time of the first Gulf War at the beginning of the
1990s, oil prices temporarily spiked above
US$40/barrel (in constant 2004 dollars). In
1998, following an up-shift in OPEC production,
which just preceded the economic and financial
crisis in Asia, oil prices fell to around US$10/
barrel. And, currently, they are well above their
normal range and are likely to stay above
longer than they did in the early 1990s.

31
Global oil supply outpacing demand...
Global Oil Supply and Demand
Y/Y% Change
5.0
4.0
3.0
2.0
1.0
0.0
-1.0
-2.0
...allowing for a rebuild of commercial inventories...
US Comercial Inventories of Crude Oil
% of 5 year average
120
110
100
1990
1992
1994
1995
1998
Demand
2000
2002
Supply
2004
However, we do expect that easing risks,
an improving ability to manage risks, and
market fundamentals will bring prices
down into their normal range during the
next year.
Global oil consumption is soaring …
There has been considerable focus on
the record rise in global oil consumption
in 2004, driven by sharp increases in
China and other nations in Asia. The
International Energy Agency (IEA)
estimates that global consumption will be
up by 2.6 million barrels per day (mmb/d)
in 2004 to 82.2 mmb/d. That jump of
3.3% would be more than double the
average annual increase of the past ten
years (1.6%). This growth is being driven
by rapidly rising consumption in China
(up an estimated 16.4% in 2004 to 6.4
mmb/d) and the rest of Asia, not including
Japan (up 4.9% to 8.5 mmb/d). Demand
growth in the rest of the world is
estimated at 2.1% for 2004.
90
80
1985
...and government strategic reserves.
US Strategic Petroleum Reserve
Millions of barrels
800
700
600
500
400
1985
1987
1987
1989
1989
1991
1991
1993
1993
1995
1995
1997
1997
1999
1999
2001
2001
2003
2003
… although global production is more
than keeping pace
Less attention has been paid to the steep
increase in global production, driven by
large gains in the Former Soviet Union,
Africa, and OPEC. Based upon IEA
estimates, it appears that global
production will rise by 3.4 mmb/d in 2004
to an average of 83.0 mmb/d. (This
assumes that OPEC continues to
produce the same amount during the rest
of the year that it did in August. This is
plausible as reduced production in Iraq
due to insurgency can be made up by
rising output in Saudi Arabia.) This 4.3%
rise in supply is one full percentage point
faster than the increase in global demand
and significantly faster than the 1.7%
average annual increase in production
during the past ten years.
With global production exceeding
demand by 0.8 mmb/d, there would be

32
an implied global stock-build of close to 300
million barrels in 2004. If OPEC were to
continue to produce at its current rate through
2005, global inventories would likely rise by a
further 400 million barrels next year.
Thus, while global demand has indeed risen
sharply, global production has risen sufficiently
to meet that demand and refill commercial
inventories to more acceptable levels and
permit a significant accumulation in national
strategic petroleum reserves.
US inventories of crude oil and products
recover
In the United States, prior to the substantial
damage to Gulf of Mexico production inflicted
by Hurricane Ivan, commercial inventories of
crude oil had almost fought their way back to
their five-year average, after showing deficits of
close to 15% late last year and in early 2004.
Similarly, gasoline inventories had been posting
new five-year highs and distillates had been
closely marking their five-year averages. In
part, the recovery in inventories had reflected
strong growth in imports of crude oil and
products. During the late-August to October
interval, however, production and import
interruptions caused by hurricanes widened the
deficit in crude oil inventories to about 6% and
pushed gasoline and distillates into deficits,
relative to five-year averages, of 1%, and 4%,
respectively. With repairs to oil production and
transportation infrastructure taking longer than
expected and leading to even tighter markets,
prices have risen abruptly. As Gulf production
and transportation infrastructure is brought
back to normal, commercial inventories of
crude oil and those of products should recover
to more normal levels, easing some pressure
on prices.
US strategic reserves nearly full
Commercial inventories would have grown
even more if the US government had not been
such a strong competitor on the consumption
side, in the rebuilding of its strategic petroleum
reserve. Prior to the September 11th terrorist
attack, the US Strategic Petroleum Reserve
had been allowed to decline. For instance,
between 1997 and 2001, it fell at an average
annual pace of 1.4%. Following September 11,
US policy shifted to an aggressive
accumulation of its strategic reserve, which
climbed 5.7% in 2002, 6.5% in 2003, and 8.5%
year-to-date in 2004.
The US strategic reserve now stands at about
670 million barrels and the government intends
to continue its rapid accumulation until the
reserve is filled to its 730 million barrel capacity.
At the current pace of accumulation – about 1
million barrels per week – the strategic reserve
would be full by next May. At that time, more oil
will become available for commercial use.
US government policy is to release petroleum
from its strategic reserve only if there are
market discontinuities, such as major
disruptions of supply that might arise, for
instance, from rebel insurgency in Nigeria.
Tight margins of spare capacity contributing
to higher oil prices
Historically, when commercial inventories have
matched their five-year average, the real price
of WTI has tended to be close to US$25/barrel
(in constant 2004 dollars), with a few notable
exceptions, as discussed above.
The current supply/demand and inventory
situation would be consistent with a price for
WTI of about US$30/barrel. This would consist
of the long-term average of US$25 and a
further $5 due to tightness in crude inventories.
The much higher level of current prices reflects
very narrow margins of OPEC excess capacity
and sharply increased risks to supply.
Historically, OPEC has had a much larger
margin of excess capacity to meet unexpected
developments. Spare capacity averaged 5
mmb/d in the 1999-2002 period. It slid to 3.2
mmb/d in 2003 and is currently near 1.5 mmb/d
(about the same as Iraq exports on a good day
and less than daily Yukos production). As a per

33
This year's surge in oil prices largely reflects...
Real WTI Oil Price
US$/bbl in constant 2004 dollars
100
80
60
40
20
0
1972:Q1
...narrowing capacity restraints and supply risks...
OPEC Spare Oil Production Capacity
% of global demand
20
15
10
5
0
...though market responses should reduce oil prices.
WTI Oil Price
US$/bbl
50
1985
1976:Q1
1987
1980:Q1
1989
1991
1984:Q1
1993
1988:Q1
1995
1992:Q1
Normal Range, Average=$25/bbl
1997
1996:Q1
1999
2000:Q1
2001
2003
2004:Q1
FORECAST
cent of global oil consumption, excess
capacity now measures less than 2%,
well below the 6.6% average during
1999-2002.
The sharp decline in excess capacity
would argue for a higher price for oil (as it
would for any commodity or product/
service). The last time excess capacity
was as low as it currently is was in 1992,
in the aftermath of the first Gulf War.
When excess capacity recovered quickly
in 1993, the average price of real WTI fell
about US$4/barrel (in the absence of a
noticeable change in the position of
inventories during that period).
It could be argued that a similar decline
in the margin of spare capacity in 2004
would result in an even larger increase in
price, given expectations that it will be
more difficult to build capacity now than it
was to rebuild capacity in the early
1990s. The current capacity squeeze
could be placing upward pressure on
prices in the neighbourhood of US$5/
barrel. Thus, even in the absence of
elevated supply risks, market conditions
would be consistent with a price of WTI
of $35/barrel (the ‘normal’ price of $25/
barrel plus $5/barrel to reflect belowaverage
crude inventories, and a further
$5/barrel due to tight capacity margins).
40
30
20
10
1998:Q1
1999:Q1
2000:Q1
2001:Q1
2002:Q1
2003:Q1
2004:Q1
2005:Q1
2006:Q1
Supply risks are behind high oil prices
In addition to the fact that excess
capacity has significantly declined, there
is now a much higher likelihood that
excess capacity will be required. During
the past year, the risk of terrorist strikes
against oil infrastructure in the Middle
East has not only risen abruptly, there
have actually been several incidents.
Additionally, social and political unrest in
Venezuela and Nigeria have raised the
potential for lost oil exports from those
countries. The ongoing Yukos affair in

34
Russia also has the market concerned that
restructuring of that company and the process
of ownership change could disrupt close to one
million barrels per day of production. The
market is also worried about the possibility of
an overthrowing of the Saudi government by
strongly anti-western factions. All of these risks
have made the market very nervous about
supply adequacy, adding a very large premium
to oil prices – which has bounced about in the
US$10-$20/barrel range during the past couple
of months.
At their current level of close to US$53/barrel
(October 8), oil prices incorporate a risk factor
estimated at $18/barrel. Some sources of risk
have been diminishing. The apparent
resolution of the presidential recall in
Venezuela in favour of Chavez has reduced
that source of supply risk for the time being.
Additionally, the market is attaching a lower
probability that the Yukos affair will significantly
disrupt production and exports in Russia, even
though the company, unable to pay
transportation fees, had to suspend a small
amount of exports to China. However,
Hurricane Ivan’s substantial damage to oil
producing infrastructure in the Gulf of Mexico
and recent indications that rebel actions
against the Nigerian government could intensify
have maintained a strong bid in the oil market.
In Nigeria, oil production has been running
around 2.4 mmb/d.
Looking ahead, we expect the risk premium to
diminish gradually during the next couple of
years. Notwithstanding recent developments,
risk related to Yukos production and exports is
likely to be eliminated within the next few
months. While risks to Iraqi production and
exports are likely to remain pronounced, they
are projected to diminish gradually as some
progress is made on the political front and the
new regime’s operating experience increases.
Looking at the market fundamentals, current
high prices and raised expectations about
longer-term prices have greatly improved the
economics of existing projects and are likely to
stimulate new exploration, development, and
production globally. Production in the Former
Soviet Union and Africa is growing at a brisk
pace, Saudi Arabia and other countries in the
Gulf are investing to expand their capacity, and
tar sands production in Canada is rising. High
prices are also likely to rein in consumption,
which responds with lengthy lags. Thus, there
should be fairly well balanced market
conditions during the next few years, although
there could be some tightness this winter.
Based upon IEA estimates and assuming
OPEC continues to produce at its current level,
global supply of oil would rise by 1.9 mmb/d to
85.0 mmb/d in 2005. A large part of that
increase would emanate from the Former
Soviet Union (rising 0.6 mmb/d in 2005
following average increases of 0.9 mmb/d
during the past two years) and OPEC (also up
an estimated 0.6 mmb/d). Output in non-OPEC
Africa is slated to rise 0.4 mmb/d next year.
The expected increase in global supply next
year should be more than sufficient to meet
rising consumption, which is expected to run at
83.9 mmb/d, and add to global inventories.
Overall, we expect the price of WTI to decline
from current levels to an average somewhere
in the range of US$33-US$38/barrel in 2005
and US$28-$33/barrel in 2006. Average prices
during the next couple of years would be at the
lower end of those ranges if the current turmoil
in Iraq diminishes. Given unsettled political
conditions in several oil producing regions and
the oncoming winter heating season, progress
towards lower prices is likely to be bumpy.
Given very tight margins of excess capacity,
unexpected shocks on the supply or demand
sides could lead to substantial price volatility
during the next couple of years.
Earl Sweet, Assistant Chief Economist
416-867-4823
earl.sweet@bmo.com