OTTAWA (Reuters) - Canada's economy unexpectedly shrank in February, disappointing markets and cooling talk that the Bank of Canada could start raising interest rates in the near future.
Statistics Canada said gross domestic product dropped by 0.2 percent in February from January, surprising analysts who had expected a 0.2 percent increase.
Statscan cited factors such as temporary closures in the mining and other goods-producing industries. Year-on-year growth was an uninspiring 1.6 percent, the weakest since the 1.2 percent recorded in January 2010.
Analysts said the data would provide food for thought at the Bank of Canada, which has warned recently that higher interest rates may be necessary to deal with a recovering economy and higher inflationary pressures.
"The Canadian economy disappointed in a big way in February ... While much of the weakness looks temporary, it drives home the point that the underlying growth rate is sluggish at best," said Douglas Porter, deputy chief economist at BMO Capital markets.
"The pullback in output will dampen some of the most hawkish views on the Bank of Canada and take some steam out of the Canadian dollar."
Porter said first-quarter growth now would be lucky to hit 2 percent, let alone the 2.5 percent that the Bank of Canada is projecting.
Statscan said potash mining fell by 19 percent after weak world demand prompted the closure of mines in Saskatchewan. Copper, nickel, lead and zinc mining fell by 9.9 percent as several nickel mines in Ontario were shut for safety reasons.
Oil and gas extraction dropped by 0.9 percent, in part due to unplanned maintenance at crude petroleum facilities in the oil-rich province of Alberta.
While analysts had expected some temporary factors to bite, they were surprised by a 1.2 percent drop in manufacturing after five consecutive increases. Utilities fell by 1.9 percent, pulled down partly by unseasonably warm weather that cut demand for electricity and natural gas.
Overnight index swaps, which trade based on forecasts for the central bank's key policy rate, showed that traders have lowered their bets on monetary policy tightening later this year.
Expectations had jumped earlier this month after the central bank used more hawkish language in its rate announcement and monetary policy report.
"There go market bets that the Bank of Canada would shift to summertime rate hikes as fed by global hot money bets, and this report is more in keeping with our view that the (bank) would not be shifting toward rate hikes this year," said Scotia Capital economists Derek Holt and Dov Zigler in a research note.
The figures knocked Canada's dollar as low as C$0.9895 versus the greenback, or $1.0106, down from the seven-month high of C$0.98, or C$1.0204, it reached on Friday.
Still, the Bank of Canada warned again on Monday it may have to pull back on policies designed to stimulate the economy, with Deputy Governor Timothy Lane reiterating the more hawkish language the BOC introduced this month and pointing to the need to keep inflation in check.
A Reuters survey of primary dealers on April 17 showed the median forecast for the timing of the next rate increase had moved to the first quarter of 2013 from the third quarter.
The central bank has kept rates at a near-record low of 1 percent since September 2010.
Avery Shenfeld of CIBC World Markets Economics said first quarter growth was likely to be no better than 2 percent, "implying that the output gap was not narrowing in the quarter as a whole, and taking us one step back from the precipice of renewed interest rate hikes".
In a separate report, Canadian producer prices rose by 0.2 percent in March from February, pushed up by higher prices for petroleum and coal products, Statistics Canada said.
The increase was less than the 0.3 percent advance forecast by market operators. Raw material prices plunged by 1.6 percent on weaker mineral fuels, a far cry from the 0.3 percent growth expected by analysts.
Additional reporting by Louise Egan; Editing by Peter Galloway