May 30, 2011 / 12:40 PM / 6 years ago

First-quarter economic growth spurt seen short-lived

<p>A condominium building under construction is seen in downtown Toronto, May 14, 2009.Mike Cassese</p>

OTTAWA (Reuters) - Canada's economy gathered speed in the first quarter, expanding at its fastest pace in a year, as businesses ramped up investment and rebuilt inventories, though economists warned the growth spurt would not last long.

The data, released by Statistics Canada on Monday, nudged the Canadian dollar lower. But it changes little for the Bank of Canada, which is widely expected to hold its benchmark interest rate at 1.0 percent on Tuesday and keep rates steady until the third quarter as growth slows.

"Heading into this, they were looking for growth of a little bit better than 4 percent in Q1, and 2 percent in Q2, and it looks like on both fronts things will be softer," said Doug Porter, deputy chief economist at BMO Capital Markets.

Led by manufacturing, mining and oil and gas extraction, gross domestic product grew at an annualized rate of 3.9 percent in the quarter.

That was the strongest performance since the first quarter of 2010, when the economy grew 5.6 percent, and followed 3.1 percent fourth-quarter growth. The economy of the United States, Canada's biggest trading partner, grew an annualized 1.8 percent in the first quarter.

In March, the Canadian economy expanded 0.3 percent, as expected, following a 0.1 percent contraction in February.

In a separate report, Statscan said strong oil exports to the United States helped shrink Canada's first-quarter current account deficit to C$8.9 billion, from C$10.3 billion.

Also on Monday, Canada Mortgage and Housing Corp, the federal housing agency, raised its forecast for 2011 housing starts to 179,500 units from 177,600, citing an improving economy and still-low interest rates.

Derek Holt, an economist at Scotia Capital, said he was disappointed by the GDP numbers because of downward revisions to the previous month and quarter.

"The concern is about Q2 and we'll be faced with some very, very soft readings for the Canadian economy in the next two to three weeks," he said.

Finance Minister Jim Flaherty said growth was sure to be slower in subsequent quarters, echoing private economists, who point to the Japanese earthquake, which cut off supplies to factories, and note that exporters continue to face a strong Canadian dollar and dull U.S. demand.

"We knew that the first quarter would be exceptional this year and that growth for the rest of the year would be more modest," Flaherty told reporters in Toronto.

The Canadian dollar firmed initially, but soon weakened to as low as C$0.9781 to the U.S. dollar, or $1.0254, from C$0.9759 just before the release.

Canada's central bank has held its key rate steady since last September following three successive increases to lift it from emergency lows.

Thirty-five of 43 forecasters in a Reuters poll last week predicted the central bank would resume rate increases some time in the third quarter, so either in July or September.

Markets see a 98 percent probability the bank will stand pat on Tuesday, according to overnight index swaps, which also suggest rate hikes are priced out for the rest of the year.

ROTATION OF DEMAND

The report confirmed expectations that the drivers of growth in the economy are shifting toward business investment and external trade and away from consumer spending.

Consumer spending was flat and final domestic demand rose 0.6 percent, down from 1.2 percent in the previous quarter.

Business inventories were the biggest contributor to the percentage increase in quarterly GDP, growing by C$10.7 billion ($10.9 billion), while business investment in plant and equipment rose 3.2 percent.

Trade was a slight drag on growth as imports grew faster than exports.

Statscan's revisions to GDP data going back three years show that the recession starting in the final quarter of 2008 was deeper than previously reported, but growth rebounded more sharply following the downturn.

Annual 2010 growth was revised to 3.2 percent from 3.1 percent, but over the three-year period, revisions were a wash.

($1=$0.98 Canadian)

Additional reporting by Howaida Sorour, Ka Yan Ng, Claire Sibonney, Euan Rocha and John McCrank; editing by Rob Wilson

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