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OTTAWA (Reuters) - Canada's economy disappointed in the third quarter with the weakest growth rate in a year, while the economy shrank outright in September, adding pressure on policy makers to safeguard the patchy recovery.
Gross domestic product growth slowed to a 1.0 percent annual rate in the July-September period as a strong currency hit exports and the housing market cooled, according to Statistics Canada data on Tuesday.
The performance fell short of market predictions of 1.4 percent growth and was down from revised 2.3 percent in the second quarter and 5.6 percent in the first quarter. The agency originally reported a second-quarter figure of 2.0 percent growth.
Although Canadian officials often boast of the country's stellar comeback from last year's recession, it was outshined in the third quarter by the United States which posted 2.5 percent growth, as well as by some other major economies.
"I must say, it contrasts rather sharply with the rest of the world," said Eric Lascelles, chief Canada macro strategist at TD Securities.
"We took a look and based on the historic relationship with some of those international GDP numbers and ours, you would have expected we'd be up in the mid 3s (percent), based on how everybody else did and we just didn't pull it off," he said.
The economy contracted 0.1 percent in September from August -- the worst showing since August 2009 -- as oil and gas extraction and factory production fell.
The Canadian dollar weakened immediately after the data and hit a session low of C$1.0286 to the U.S. dollar, or 97.22 U.S. cents, down from 98.17 U.S. cents at Monday's close. Canadian government bond yields were lower.
Analysts said the weak GDP could prompt the Bank of Canada to keep its benchmark interest rate on hold longer than previously thought.
The central bank lifted borrowing costs three times between June and September, becoming the first among the Group of Seven advanced countries to do so after the global financial crisis. It has since held rates at 1 percent. While no one sees a change at its next meeting on December 7, markets are divided over the timing of the next hike in 2011.
"There had been some move in recent weeks to price in earlier Bank of Canada hikes. I think this will put the market back a step or two," said Doug Porter, deputy chief economist at TD Securities.
In a Reuters poll of 12 primary securities dealers on October 19, seven saw rates unchanged through March next year while five expected one hike or more by then.
Markets on Tuesday were pricing in a 99.86 percent probability the bank holds rates steady in December, up from 95.59 percent just before the data.
The news also comes as officials from the Conservative government tour the country seeking the public's opinion on the next budget, expected in early 2011 and which will lay out plans for fostering growth once stimulus spending ends.
Canada's brisk recovery from a mild 2009 recession began to lose momentum midway through this year as the trade-reliant country could not shake free of the troubles hobbling its top customer, the United States.
Exports fell 1.3 percent in the third quarter after a year of gains, largely because of anemic U.S. demand for Canadian-made cars and oil. Housing investment also fell for the first time since early 2009, dropping 1.3 percent as the once-overheated market cooled.
However, there was evidence that much-needed business investment was making a comeback with growth at a five-year high. Investment in plant and machinery grew 4.6 percent, a trend likely to please policy makers who have been urging the private sector to spend more to keep the recovery going.
"It's encouraging. It shows that business is indeed responding to the strong Canadian dollar and the upturn in domestic spending," said Porter.
However, he said it was a "pipe dream" to think business investment alone could power the recovery. "You need the consumer and exports to really make the recovery solid."
Consumer spending showed no sign of slowing and continues to drive the economic recovery, advancing 0.9 percent in the quarter. Likewise, the hard-hit manufacturing sector proved resilient to the strong currency and was one of the main contributors to growth.
Additional reporting by Ka Ya Ng, Jennifer Kwan and John McCrank in Toronto; editing by Jeffrey Hodgson