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.
"While we believe that the most likely outcome is a mild pick-up in growth over the second half, the starting point is even weaker than we expected and there are still clearly plenty of potential dangers lurking ahead for the economy."
The GDP report showed mining, oil and gas extraction fell 5.3 percent in May from April, hit by wildfires and maintenance shutdowns in energy-rich northern Alberta, and by bad weather that cut drilling activity.
While the usually strong sector is expected to rebound, BMO's Porter noted that GDP still would have declined 0.1 percent in the month if mining and energy were excluded, suggesting the weakness was widespread.
The hard-hit manufacturing sector, already battling a strong Canadian dollar and weak U.S. demand, dropped 0.4 percent, in part because of supply problems caused by the major earthquake and tsunami in Japan in March.
The output of nondurable goods fell 1.4 percent as refineries across the country shut down for maintenance, while durable goods production rose 0.4 percent.
Wholesale trade rose 1.0 percent, boosted by the currency, while retail trade edged up by 0.2 percent as activity at building material, garden equipment and general merchandise stores offset lower activity at grocery stores and new car dealers.
A separate report from Statistics Canada showed lower fuel prices helped cut prices for both Canadian industrial products and raw materials in June over May.
Industrial product prices dropped for the second month in a row, falling by 0.3 percent. Market analysts had forecast a 0.1 percent decline.
The main reason for the decline was a 2.8 percent fall in prices for petroleum and coal products, led by a 4.3 percent fall in gasoline prices. This followed the decision by some oil exporters to increase production.
Raw materials prices fell by 2.2 percent in June from May as the prices for mineral fuels dropped by 4.9 percent. The decline was partially offset by a 4.6 percent increase in price for vegetable products.
Writing by Andrea Hopkins; Editing by Frank McGurty