OTTAWA (Reuters) - Canada's economy revved back to life in late 2010 on the back of surging exports, raising expectations its central bank will hike interest rates by mid year and pushing the Canadian dollar to a three-year high.
The growth rate rose to 3.3 percent annualized in the fourth quarter, beating the U.S. growth of 2.8 percent and exceeding the 3 percent market estimate.
Statscan's revision of third-quarter expansion to 1.8 percent from 1.0 percent provided an extra lift to sentiment as markets look ahead to the Bank of Canada's interest rate decision on Tuesday. The central bank is expected to keep rates unchanged, but may toughen language to prepare the market for tighter policy in coming months.
An impressive comeback for exports also helped narrow Canada's current account deficit to C$11.05 billion in the same quarter from a record C$16.98 billion, the government statistics agency said.
"It's a stunning gain in exports," said Sal Guatieri, senior economist at BMO Capital Markets. "It's a fairly solid report and (there's) plenty of momentum heading into the new year, given the strong gain in December."
The economy advanced 0.5 percent in December on strength in oil and gas extraction and wholesale trade, again outperforming the market forecast of 0.3 percent growth.
The Canadian dollar rose to C$0.9718 to the U.S. dollar, or $1.0290, after the data, its highest level since February 2008. Money market rates and bond yields rose as traders priced a higher likelihood that Canadian interest rates will rise within months.
The reports show Canada's recovery is gaining steam after a sluggish period last year when anemic U.S. demand and a strong currency hit exports.
Canada sells most of its exports to the United States and the economy normally grows and shrinks in tandem with its giant neighbor. However, the country set itself apart during the global financial crisis as its housing and banking sectors emerged largely unscathed.
Strong consumer spending fired the subsequent recovery in Canada and the jobless rate dropped to below U.S. levels in a break with historical patterns.
Lawmakers from the minority Conservative government immediately boasted that the growth placed Canada at the front of the pack of the Group of Seven advanced economies. But with many political observers predicting a spring election over the budget, the government also attacked opposition calls to cancel corporate tax cuts as an economic threat.
"How incredibly stupid it would be to undermine (the recovery) through tax hikes," wrote Immigration Minister Jason Kenny on his Twitter feed.
Investors are now looking to the Bank of Canada's rate announcement on Tuesday at 9 a.m.. While nobody predicts a near-term rate hike, some economists believe the fourth-quarter gains may prompt the Bank of Canada to adopt a more hawkish tone in its statement.
"While we still believe that the Bank will wait until the Fed is done easing before it begins to raise rates ... we do admit that further strong data like today's GDP report ... raises the odds of the Bank hiking a little sooner," said Jacqui Douglas, a currency strategist at TD Securities.
The bank raised borrowing costs three times between June and September last year, bringing its key rate to the current 1 percent level. Analysts polled by Reuters last week saw May 31 as the most likely date for the next increase.
The Bank of Canada, which has a mandate to keep inflation low, is under little pressure on that front. Canada defied a global trend of rising price in January, reporting a tame 2.3 percent annual inflation rate and 1.4 percent core inflation.
The GDP price deflator, a broad measure of price gains in the economy, showed inflation picking up with a 0.9 percent quarter-on-quarter gain in the fourth quarter compared with a 0.4 percent increase in the previous quarter.
The strong currency could continue to dampen inflation, analysts say, but there is also a risk that the global commodity price pressures could spill over into the domestic economy.
"Just as the second wind is picking up steam, a new set of headwinds is emerging in terms of the recent spike in crude oil, food and energy prices," Brian Bethune and Arlene Kish of IHS Global Insight wrote in a research note.
Bank of Canada Governor Mark Carney had flagged the record current account deficit in the third quarter as a top concern, blaming it partly on the sharp currency appreciation.
But exports once again saved the day in the fourth quarter, shrinking the gap by C$5.93 billion.
The balance in trade in goods swung to a C$523 million surplus from a C$6.42 billion deficit in the third quarter, as exports of industrial goods and energy products surged.
Nonetheless, 2010 as a whole saw a record current account deficit of C$49.98 billion, up from a record C$43.52 billion in 2009.
Additional reporting by Ka Yan Ng, Solarina Ho and Howaida Sorour; editing by Jeffrey Hodgson