December 2, 2007 / 12:22 AM / in 10 years

Economy grows more than expected in quarter

OTTAWA (Reuters) - Economic growth slowed to an annualized 2.9 percent in the third quarter, Statistics Canada said on Friday, but that was stronger than expected as bulging business inventories and consumer spending offset a drag from trade.

Analysts had expected a 2.2 percent annual growth rate in the quarter, and the Bank of Canada had projected 2.5 percent. The central bank says the economy can grow by 2.8 percent without fueling inflation.

Statscan also revised growth in gross domestic product for the second quarter to 3.8 percent from 3.4 percent.

The stronger-than-expected economic performance complicates life for the Bank of Canada as it ponders whether to cut interest rates on December 4 because of signs that the lofty Canadian dollar is hurting exports.

“It sort of creates a dilemma for the Bank of Canada because they know that their rate cuts can’t really do much to boost manufacturing or trade,” said David Watt, senior currency strategist at RBC Capital.

“So all they would basically be doing is cutting interest rates to further boost domestic demand, and the domestic side of the Canadian economy is saying we don’t really need the help right now.”

The central bank has kept its lending rate unchanged at 4.5 percent since July but a majority of market players now expect at least one 25 basis-point cut by the end of January.

The Canadian dollar gained initially after the report but later fell to US$1.001, or 99.89 Canadian cents, from levels of about US$1.004, or 99.60 Canadian cents, before the GDP figures were released. Bonds tilted slightly lower.

In the third quarter, the economy advanced 0.7 percent from the second -- the weakest performance this year.

Businesses added C$15.4 billion worth of goods in nonfarm inventories in the third quarter, the biggest buildup since the second quarter of last year. Retailers’ inventories accounted for $9 billion of that, the majority of it in the accumulation of vehicles, Statscan said.

That likely spells slower growth in coming quarters as businesses work off their stock.

“I‘m not too overly concerned about that because most of it came from imports,” said Carlos Leitao, chief economist at the Laurentian Bank of Canada. “Next quarter inventories will be worked out, and that will be negative for growth, but at the same time, we will also see a much tamer import number, so I think one will offset the other.”

Companies took advantage of lower prices to import more machinery and equipment. Those imports jumped 6.4 percent.

“Perhaps the best news here is the strength in business investment. Business investment had been a little bit disappointing in prior quarters, and it’s encouraging to see that the surge we saw in imports was largely driven by a run-up in machinery and equipment investment spending,” said Doug Porter, deputy chief economist at BMO Capital Markets.

Growth in consumer spending eased to 0.7 percent in the third quarter from 1.5 percent in the second quarter, for its weakest quarterly performance since 2005. However, consumer spending remained the second biggest contributor to growth.

Additional reporting by John McCrank in Toronto; Editing by Peter Galloway

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