August 1, 2008 / 1:12 AM / 9 years ago

May GDP drops; rates seen on hold

OTTAWA (Reuters) - Growth shrank unexpectedly in May, underlining both the relative weakness of the economy and expectations that the Bank of Canada will have little room to raise interest rates until next year.

Gross domestic product fell by 0.1 percent in May compared with April, pulled down by a significant decrease in the energy sector, Statistics Canada said on Thursday.

Analysts -- who on average had expected a 0.2 percent increase -- said the May figure was disappointing, with one describing it as “a bit of a shocker.”

The Canadian economy unexpectedly shrank in the first quarter of 2008 by an annualized 0.3 percent. It was the first contraction since the second quarter of 2003. Economists expect 2008 growth of just 1.1 percent on an annualized basis.

GDP grew by 0.4 percent in April over March. If June growth is low enough to produce another consecutive quarter of decline -- meeting the technical definition of a recession -- that would cause problems for a minority Conservative government already under pressure over job losses and high gas prices.

“The fact that all the surprises in this latest result were to the downside vividly shows how the economy is struggling to grow,” said Douglas Porter, deputy chief economist at BMO Capital Markets in Toronto.

Canada is struggling with to cope with high energy prices and the reverberations from the U.S. credit crisis.

Statscan said the main reason for the month-on-month decline in May was a 0.9 percent drop in the energy sector, which was dragged lower by decreases in natural gas production and crude oil production.

The Bank of Canada is forecasting 0.8 percent growth in the second quarter, but analysts said that figure is looking overly optimistic.

“We assume a flat June reading for GDP, the second quarter might only be as high as 0.5 percent. That suggests the Bank will not really be in a position to raise rates until well into 2009,” said Charmaine Buskas, a senior economics strategist at TD Securities.

A Reuters poll of 10 Canadian primary securities dealers on July 11 showed that eight expected the bank to raise rates at some point next year.

Overall inflation shot up to 3.1 percent in June, well above the Bank of Canada’s 2 percent target. The central bank expects surging oil prices to boost inflation to hit 4.3 percent early next year.

The Bank left interest rates on hold at 3 percent on July 17 and gave no indication it would move again soon.

Statscan noted declines in finance, forestry, construction and wholesale trade in May while there were advances in manufacturing, retail trade and the public sector.

“(It is) difficult to find a silver lining in this report, if indeed one exists at all,” said Stewart Hall, a market strategist with HSBC Securities.

The data helped push down the Canadian dollar, which at 9:55 a.m. EDT was at C$1.0245 to the U.S. dollar, or 97.61 U.S. cents, down from C$1.0228 to the U.S. dollar, or 97.77 U.S. cents, at Wednesday’s close.

Reporting by David Ljunggren; Editing by Frank McGurty

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