The economy is set to grow in 2011 thanks to low mortgage rates and government stimulus spending, but record deficits will mean hard choices in the near future, according to a new forecast by RBC Economics.

"The past year has been, by far, the toughest since the early 1990s recession and, in some cases, the early 1980s recession," the report said.

RBC predicts real gross domestic product will rise by 2.6 per cent next year and will continue to expand in 2011, at a 3.9 per cent clip, although the economy contracted at an average of 2.5 per cent this year.

"The price tag for the fiscal stimulus is enormous — huge budget deficits," the report said.

The bank suggests the peak of stimulus spending will occur in 2010, with improving credit conditions fueling growth next year and in 2011. It noted that collectively, the provinces are projecting record deficits totalling $38.2 billion in the 2009-10 fiscal year and at least $30.2 billion in 2010-11 (with two provinces not providing estimates).

The bank's report was generally supportive of the massive stimulus spending, saying that relative to GDP, the deficits will still be modestly milder than the peaks in the early 1990s. It also argued that the alternative of not spending was "less attractive given the severity of the economic downturn."

"Nonetheless, balancing the government books in the medium term will be a challenge and will require difficult choices," said the report.

Consumer spending to increase

Besides government spending, the report projects consumer spending will also increase by 2.3 per cent next year before accelerating to 2.7 per cent in 2011.

"Extremely low mortgage rates have been key to the spectacular rebound in housing resale activity in every province since early 2009.

"In turn, this housing resurgence should be seen as evidence that consumers are feeling more upbeat even in areas of the country such as British Columbia, Ontario and Alberta where the recession caused substantial damage," the report said.

Not all is rosy. The jobless rate is expected to remain high at about 8.7 per cent in 2010 before falling to 7.8 per cent in 2011.

"With the financial crisis behind us and the U.S. economy on the mend, Canada's economic growth is expected to rise steadily throughout the next year," said Craig Wright, RBC senior vice-president and chief economist.

"While challenges remain, a peak in stimulus and infrastructure spending across the federal, provincial and municipal governments, along with low interest rates, should result in a sustained recovery."