The world will head into a mild recession in 2009 before bouncing back the following year, says a new report released by TD Economics. The report added that while home prices will bottom out over the next 12 months and the worst of the financial firm failures in the U.S. will be over, don't expect the economic situation to return to normal once the recovery occurs.

"Don't expect a return to the status quo; at least as we had come to understand that condition prior to the summer of 2007. In all probability, the cost of financing will remain higher than the inappropriately low levels that prevailed earlier in the decade," wrote TD chief economist Don Drummond and TD's director of economic forecasting Beata Caranci. "While the balance sheets of financial firms will be much improved, they will likely also be far less leveraged than in the past, which means less availability of credit."

As a result, financial constraints on the real economy will gradually abate, but a "convincing and sustainable recovery in consumption and investment won't necessarily materialize until 2010," they say.

Canada's economy will also move into recession in 2009 before heading into a shallow recovery at the end of the year, the report says.

TD economist Diana Petramala said in a sidebar commentary that 2008 growth in Canadian GDP should come in at a "slight 0.7%," while in 2009 it will expand to a "tepid 1.2%."

A global recession and weakened U.S. demand will eat into Canadian exports while cooling housing and employment will undermine domestic demand growth, she wrote. Finally, tighter credit conditions will slow business and consumer expenditures, she added.

"Once a world recovery takes hold in late 2009, we can expect a sustained recovery in Canada with real GDP growth of 2.7% in 2010," she writes.

In the U.S., GDP growth will essentially "move sideways," growing only 1.1% in 2009 as weaker exports provide less of an offset to an already recessionary domestic economy, says TD economist James Marple.

"You have to look at more indicators than just heaedline GDP growth," Marple said, pointing to TD's forecast of U.S. unemployment rate rising to almost 7% in 2009 and American income growth stalling. Despite the small growth in GDP, the U.S. will be in a recession in 2009, Marple added.

While recent shockwaves in the U.S. financial system have increased economic uncertainty, the TD economists say their base-case projections remain very similar to their forecasts prior to the collapses.

"The reaction of policy authorities provides assurance that financial markets will not free fall, but it does not give an instantaneous or significant lift to economies being dragged down by the battered balance sheets of financial institutions, households and increasingly, governments. On balance, our September 2008 forecasts are similar in shape but slightly weaker on growth prospects than our previous outlook of June," Drummond and Caranci wrote.

By Sean McKibbon and edited by Nancy Girgis
©CEP News Ltd. 2008