Broad and deep deleveraging in core financial markets is generating significant volatility and generally higher risk premia.

Tighter financial conditions will be a significant drag on the U.S. and other economies for some time.

Aggressive actions by the Fed should help to limit the U.S. slowdown, but the outlook is subject to heightened uncertainty.

Emerging economies are also expected to slow in coming quarters, but policy offsets should limit the impact of the U.S. led slowdown on the emerging world.

U.S.

Recessionary conditions may be unfolding in the U.S. economy. The slowdown appears to be spreading with reinforcement from unstable financial markets, which appeared close to seizing up in recent days.

Dramatic policy innovations have aided liquidity, but credit availability has tightened and lower rates have failed to ease strains on capital markets.

With housing activity still declining and joblessness creeping higher, headwinds are forming against a timely and sustained return to trend growth despite an imminent boost from recent fiscal action.

As long as inflation expectations remain checked, we expect underlying inflation to recede somewhat, aiding policy flexibility and shortening recession.

Canada

Anemic U.S. final demand growth, last year’s rapid appreciation of the Canadian dollar (CAD), and ongoing financial market strains will continue to weigh on the Canadian economy over the medium term.

Both headline and core consumer inflation probably will remain below the 2% target in 2008, before returning to target in late 2009.

Flagging output and moderating inflation near-term, likely will prompt an additional 50-75 basis points of BoC easing by June.

However, a meaningful worsening in Canadian financial conditions could warrant a slightly lower rate.