November 29, 2013 / 1:52 PM / 4 years ago

Canada's economy gathers speed, no rate move expected

OTTAWA (Reuters) - Canada’s economy grew at the fastest pace in two years in the third quarter but the pickup failed to quell doubts about the economy’s underlying strength, and analysts still expect interest rates to stay at the current low level well into 2015.

People walk by a Loblaw Companies Limited grocery store with a Joe Fresh clothing store inside, on the day of the annual general meeting of shareholders in Toronto, May 2, 2013. REUTERS/Mark Blinch

Real gross domestic product grew by 2.7 percent, annualized, in the July-September period, driven mainly by consumer spending, business inventory accumulation and signs of a rebound in business investment.

The Statistics Canada report on Friday followed a disappointing 1.6 percent GDP gain in the second quarter. The performance beat the median forecast of 2.5 percent growth in a Reuters poll and was well above the Bank of Canada’s 1.8 percent estimate last month.

The news could be the first sign the economy is pulling out of a slow spell to lift chronically weak inflation, which has been flagged by the Bank of Canada as the reason interest rates are now on hold for the foreseeable future.

“It does put a slightly healthier glow on the economy than (the Bank of Canada) suspected, so I believe they will be completely neutral at next week’s meeting,” said Doug Porter, chief economist at BMO Capital Markets.

The Bank of Canada surprised markets last month by dropping any mention of future interest rate hikes after 18 months of warning Canadians that higher borrowing costs were on the horizon.

While few expect the bank to actually lower rates, market players are watching to see if its outlook becomes even more dovish in its December 4 rate announcement.

Still, many economists were unconvinced that the third-quarter GDP report is the start of a new phase of stronger growth because expansion in quarter continued to be largely driven by debt-ridden consumers.

Porter said he suspects the third-quarter surge may be an “outlier”, reflecting a reversal of the impact in the second quarter of severe flooding in Alberta and a construction workers’ strike in Quebec.

Also, as in the U.S. third-quarter GDP report, a massive buildup of inventories played a big part in the strong number, contributing about 1.2 percentage points.

Farmers added C$4.1 billion to their inventories, the biggest buildup since 1981 after a record crop of canola and wheat. Nonfarm inventories jumped by C$5.2 billion.

“Perhaps the best way to look at the quarterly numbers would be by averaging the second and third quarter ... so the average growth rate of just a little bit more than 2 percent is a fair reflection of the underlying growth trend in the economy,” Porter said.

The central bank says growth of about 2.5 percent is needed to put a substantial dent in excess economic slack, predicting the economy will return to full capacity at the end of 2015.

Economists in a Reuters survey predict the bank will start tightening monetary policy in the second quarter of 2015 and none expect any rate move in the bank’s December 4 rate announcement.

The Canadian dollar firmed after the GDP data was released, strengthening to C$1.0564 to the U.S. dollar, or 94.66 U.S. cents, from Thursday’s close of C$1.0587 or 94.46 U.S. cents.

INDEBTED CONSUMERS

Canadian central bank chief Stephen Poloz has said business investment and exports must gain traction and replace consumers as engines of growth over the next two years.

Only small steps in that direction were evident in the GDP report.

“About two-thirds of this is shouldered once more by the indebted consumer,” said Jimmy Jean, economist at Desjardins Capital Markets. “It remains that the ‘great rotation’ in the composition of Canadian growth calls for more patience.”

Household spending slowed in the quarter to a 2.2 percent annualized rate from 3.6 percent in the second quarter, but was still the biggest driver of growth.

Business investment in machinery and equipment jumped 2.2 percent after shrinking in the second quarter but contributed only about 0.2 points to the overall GDP growth.

Exports - the other potential economic engine - have disappointed and subtracted from GDP.

($1=$1.06 Canadian)

Additional reporting by Alex Paterson in Ottawa and Leah Schnurr in Toronto; Editing by Chizu Nomiyama, Jeffrey Hodgson and Peter Galloway

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