OTTAWA (Reuters) - Canada's economy shrank unexpectedly in February, nudging the Canadian dollar lower and reinforcing expectations that the central bank will hold interest rates steady until the second half of this year.
Following two months of robust growth, gross domestic product slid 0.2 percent in February from January, Statistics Canada said on Friday, with the auto sector dragging down manufacturing-production and wholesale-trade figures.
The slump -- the first since September and the largest since May 2009 -- is bad news for the Conservative government as it heads into the May 2 general election. It has been campaigning on its success in boosting economic growth.
The economic performance was worse than any of the 22 analysts surveyed by Reuters had expected. The median forecast was for GDP to remain flat.
"After a strong showing at the turn of the year, Canadian economic momentum has downshifted," said Benjamin Reitzes, economist at BMO Capital Markets.
The blip in February may cause markets to pare back their forecasts for first-quarter growth, he said, and raise the possibility that the Bank of Canada will stall on raising interest rates hikes longer than had been thought.
"We anticipate the bank will restart its tightening program in July, though the risk now appears to be toward a later move," Reitzes said.
The Canadian dollar immediately weakened after the report to C$0.9515 to the U.S. dollar, or $1.0505, and continued to fall to C$0.9542 an hour later, compared with Thursday's North American finish of C$0.9510 to the U.S. dollar and C$0.95.
Eight of 12 primary dealers in a Reuters poll on April 19 forecast the Bank of Canada would lift its benchmark borrowing rate from the current 1.0 percent in July.
Yields on overnight index swaps, which reflect market expectations for the policy rate, showed a slightly lower probability of a rate hike on the bank's May or July policy-announcement dates than on Thursday, with a quarter-point increase fully priced in by September.
Finance Minister Jim Flaherty said the February slump was a reminder the recovery is not fully guaranteed.
"It shows that we need to be careful, that the economic recovery is fragile," he told reporters at an impromptu news conference in Whitby, Ontario, held to attack the left-leaning New Democrats, who are surging in the election polls.
After calling the NDP's economic proposals "dangerous" and "amateur", Flaherty said: "There are going to be bumps along the road like we've seen in the past, particularly in the United States and Europe. These are matters of concern to Canadians, or ought to be."
David Tulk, rates and foreign exchange strategist at TD Securities, said that despite the February downturn, first-quarter growth will likely be robust at about 3.5 percent, annualized.
"As such, we would encourage looking beyond the tree that is this morning's disappointing headline and focus on the quarterly forest," he said in a note.
Manufacturing production fell 1.6 percent in the month following a sharp 2.5 percent increase in January with most of the weakness stemming from the auto sector. Overall goods-producing industries were down 0.6 percent.
At the same time, wholesale was down 1 percent and transportation was off by 0.7 percent. However, the service sector overall was unchanged as strong consumer spending boosted retail sales.
Reporting by Louise Egan and Howaida Sorour; editing by Peter Galloway