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OTTAWA (Reuters) - Canada's economy lost some fizz in the third quarter as exports suffered their biggest drop in three years and businesses scaled back investments, though the slowdown is unlikely to knock the Bank of Canada off its rate-hike stance.
The economy grew at a weaker-than-expected 0.6 percent annual rate in the July-September period, after two straight quarters of 1.7 percent expansion, according to Statistics Canada data on Friday.
Growth stalled in September for the second straight month, suggesting a weak start to the fourth quarter and possibly more sub-par growth.
Canada recovered more quickly than its developed-nation peers from the recession, but growth has been sluggish this year as businesses and individuals remain wary thanks to a choppy economic recovery in the United States and an ongoing debt crisis in Europe.
The Bank of Canada and economists had anticipated a slowdown in the third quarter, although a milder one, so the news won't change the bank's view that interest rate hikes are needed down the road, analysts said.
"The Bank of Canada bias is very much a long-term bias so it's not going to be changing any time soon," said Michael Gregory, senior economist at BMO Capital Markets.
"But there is no question the Canadian economy is underperforming a bit here and if this continues past the turn of the year and the whole 'fiscal cliff' in the U.S., we could see a different tone from the Bank of Canada. But it is way too early for that to be happening now," he said.
The bank has held its benchmark rate at 1 percent for more than two years and has clearly signaled intentions to tighten monetary policy, although not imminently.
Overnight index swaps, which trade based on expectations for the central bank's key policy rate, showed that traders increased their very small bets on a rate cut in 2013 after the data.
The GDP result fell short of the 0.9 percent growth forecast in a Reuters poll and the central bank's 1 percent forecast. Canada's performance contrasted with that of the United States, which grew by 2.7 percent in the quarter, although that figure reflected a lift in inventories and there were few signs of underlying strength.
The Canadian economy grew just 0.1 percent compared with the previous quarter and 1 percent from a year earlier.
The Canadian dollar weakened to a session low of C$0.9954 to the U.S. dollar immediately after the data. It later regained somewhat to C$0.9940, or $1.0060 compared with Thursday's close of C$0.9928, or $1.0073.
Business investment, which has leveled off this year after solid growth last year, slid 0.6 percent quarter-on-quarter for the first decline since mid-2009 and down from a 1.3 percent burst in the second quarter.
Exports, hard hit by a relatively weak U.S. economy and a strong currency, fell 2 percent in the third quarter compared with the second, the biggest drop since the second quarter of 2009, Statscan said.
In another sign the country's hot housing market is cooling, investment in residences fell 0.9 percent due to slower resale activity. Housing construction grew 1.6 percent, about half the average growth during each of the previous five quarters.
Consumer spending continued to be the main driver of growth in the quarter, growing at the fastest pace in two years.
The Bank of Canada projects an upturn in the fourth quarter with growth of 2.5 percent, but the latest figures make that look overly optimistic.
"Expectations had been that after a weak third-quarter activity we would bounce back in the fourth quarter," said Paul Ferley, assistant chief economist at Royal Bank of Canada.
"It could still be the case, there were some temporary factors that don't look like they have fully reversed as yet, we may see that in October, but it may limit the rebound in the fourth quarter to something closer to 2 percent."
Additional reporting by Alex Paterson in Ottawa; Andrea Hopkins, Allison Martell, Alastair Sharp and Euan Rocha in Toronto; Editing by Andrea Ricci