August 31, 2010 / 12:40 PM / 7 years ago

Canadian economy slows sharply in second quarter

OTTAWA (Reuters) - Canada’s economic growth rate slowed more sharply than expected in the second quarter due to a slowdown in consumer spending and a weaker trade performance, fueling uncertainty about the pace of interest rate hikes by the Bank of Canada.

Gross domestic product rose 2.0 percent at an annual rate, sharply down from 5.8 percent in the first quarter and also down from 4.9 percent in the fourth quarter of last year, Statistics Canada said on Tuesday. The agency revised its first-quarter figure down from 6.1 percent reported initially.

The gain returned Canada’s GDP back to its pre-recession level but was below the consensus forecast for 2.5 percent annualized GDP growth in a Reuters poll. Only one of the 20 poll participants had predicted growth as low as 2.0 percent.

“Clearly the headline is below expectations and taken together with the downward revision to the first quarter, sets a much more modest profile for the Canadian economy than certainly the Bank of Canada had expected,” said Doug Porter, deputy chief economist at BMO Capital Markets.

The Bank of Canada’s next interest rate decision is September 8. Markets are unsure whether it will hike its key policy rate, now at 0.75 percent, or pause while monitoring fallout from the uncertain U.S. recovery. The central bank hiked rates in both June and July.

“This definitely raises more questions than answers,” Porter said, referring to the monetary policy decision.

The Canadian dollar weakened to a session low of C$1.0662 per U.S. dollar, or 93.79 U.S. cents, after the data. Canadian bond prices firmed, with the yield on the rate sensitive two-year bond falling to 1.197 percent from 1.227 percent just before the data.

On a quarterly basis, the economy expanded 0.5 percent versus 1.5 percent in the first quarter but monthly growth in June was brisker than in the previous two months at 0.2 percent.

That may have been the glimmer of hope that prompted Finance Minister Jim Flaherty to herald the data as a good sign, in contrast to the still-fragile global recovery.

“Today’s GDP numbers show that Canada’s economy is on the right track,” Flaherty said.

Unlike the United States, Canada’s labor market has also proven stronger than expected in the second quarter.

CONSUMER SPENDING MODERATES

Consumer spending had been the main driver of Canada’s rapid rebound from a mild recession, but it moderated in the second quarter to 0.7 percent growth from a 1.0 percent gain in the first quarter as Canadians bought fewer cars and the housing market cooled, Statscan said.

The sputtering U.S. economy dampened exports, which advanced 1.5 percent compared with 2.6 percent in the previous quarter.

On the positive side, imports rose at more than twice that pace and business investment in machinery and equipment made a long-awaited comeback with the biggest quarterly gain since 2005 at 3.5 percent.

“The fact that final domestic demand held up pretty well means it’s not quite as disappointing as the headline release,” said Mark Chandler, head of fixed income and currency strategy at RBC Capital Markets.

“So I think in spirit, the bank would see this as probably something close to consensus. It still makes it a very very tight call for next week’s rate meeting,” he said.

Ten of Canada’s 12 primary securities dealers surveyed by Reuters after the GDP data on Tuesday said there’s enough momentum in the economy to justify raising the key policy rate to 1 percent on September 8, but most see it as the last such move this year.

Markets are pricing in less than a 50 percent chance of a hike next week, according to a Reuters calculation using data on overnight index swaps.

A buildup of inventories and expanded output in mining and manufacturing also drove growth in the quarter.

The Bank of Canada anticipated in its July forecasts that Canadian consumer spending would slow and global growth weaken, but it still predicted stronger second-quarter growth of 3.0 percent.

It also said it expected business investment and net exports to make a larger contribution to growth in the second half of this year.

While business investment appears to be on track, analysts say the bank may flag the weaker U.S. economy as a key risk to Canada in its statement next week. Exports to the United States, which account for about 75 percent of the total, have been slowing as a result of anemic demand in the neighboring country.

Additional reporting by Jennifer Kwan, John McCrank, Claire Sibonney in Toronto and Howaida Sorour in Ottawa; editing by Jeffrey Hodgson and Peter Galloway

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