Canada GDP shrinks in May; rate hike seen less likely

Fri Jul 29, 2011 9:54am EDT
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By David Ljunggren

OTTAWA (Reuters) - The Canadian economy unexpectedly shrank in May as bad weather, a strong Canadian dollar and weak U.S. demand took a toll, cutting expectations for an autumn interest rate hike by the Bank of Canada.

Canada's gross domestic product - a measure of all goods and services produced within Canadian borders - fell 0.3 percent in May from a month earlier, the largest drop since a matching decrease in May 2009, government data showed on Friday.

Market analysts on average had expected a 0.1 percent increase from April. The unexpected weakness suggested the Bank of Canada will not meet its second-quarter GDP forecast and lowers the likelihood the central bank will raise rates in the autumn.

"I just don't see the (Bank of Canada) swinging toward a fall rate hike with numbers like we're getting of late on the inflation and growth fronts, not to mention the state of the global debt picture," Scotia Capital economist Derek Holt said in a research note.

Analysts said the weak May report means annualized growth for the second quarter as a whole is unlikely to reach the Bank of Canada's 1.5 percent forecast, with one economist penciling in 0.5 percent growth and another forecasting 1.3 percent. That's well down from the 3.9 percent pace in the first quarter.

U.S. second-quarter economic growth also came in weaker than expected and the outlook there was grim, given stalemated talks to cut the U.S. deficit and avoid a debt default. Lower government spending aimed at taming the deficit will dampen growth further.

The unexpectedly weak reports sent the Canadian dollar to a session low against its U.S. counterpart. The currency slipped as low as C$0.9590 versus the U.S. dollar, or $1.0428, from about C$0.9511, or $1.0514 before the data was released.

"Canada's economy was hit by one thing after another in the spring, and it now faces yet another hurdle from the deepening uncertainty emanating from the U.S. debt drama," BMO Capital Markets deputy chief economist Doug Porter said in a note.   Continued...