May 31, 2010 / 12:41 PM / in 7 years

Canada recovery zooms, rate hike widely expected

OTTAWA (Reuters) - Canada’s economy expanded at the fastest clip in more than a decade in the first quarter, fueling expectations that on Tuesday the Bank of Canada will become the first G7 country to raise interest rates since the start of the recession.

<p>A construction worker works on building new homes in Calgary, May 31, 2010. REUTERS/Todd Korol</p>

Statistics Canada said on Monday that consumer spending, a hot housing market and a return of business investment helped boost gross domestic product by 6.1 percent at an annual rate in the quarter, the biggest jump since the fourth quarter of 1999.

Analysts had predicted 5.9 percent annualized GDP growth following revised 4.9 percent growth in the fourth quarter of last year.

“It would take some fancy footwork for the Bank of Canada to pass on hiking rates tomorrow after the Canadian economy just doubled the U.S. first-quarter growth pace,” said Scotia Capital economists Derek Holt and Karen Cordes Woods in a note.

Two quarters of speedy recovery following three quarters of contraction have left real GDP about 0.5 percent lower than its prerecession levels, economists said.

The economy grew 1.5 percent compared with the fourth quarter of last year, Statscan said.

The GDP numbers were broadly in line with the Bank of Canada’s latest projections. Most forecasters polled by Reuters expect the central bank to raise rates by 25 basis points on Tuesday to 0.50 percent.

“Effectively for them this is no surprise,” said Doug Porter, deputy chief economist at BMO Capital Markets.

“I don’t think it really changes the mix for the Bank of Canada from a purely domestic standpoint. There is just no debate that the Bank of Canada should be raising interest rates.”

The Canadian dollar rose to C$1.0452, or 95.68 U.S. cents, after the data, up from Friday’s North American finish of C$1.0520 to the U.S. dollar, or 95.06 U.S. cents.

Yields on overnight index swaps, which trade based on expectations for the central bank’s key policy rate, now suggest there is a 83.6 percent chance of a 25 basis point hike on June 1, slightly higher than before the GDP report. Expectations for the July, September, October and December rate announcements have also risen, as have bond yields.

A second Statscan report on Monday showed producer prices continued to edge higher in April, by 0.3 percent, due to primary metals products prices. Crude oil prices drove raw materials up 1.7 percent in the month.

CONSUMER IS KING

Consumer spending continued to be a key driver of recovery from Canada’s mild recession, and while exports continued to recover in the period, they were outpaced by import growth.

The housing market remained hot in the first quarter because of heavy investment in new construction and home renovations by owners taking advantage of a tax credit that expired on February 1.

If there were any surprise, they were that inventories rose after being drawn down for the previous four quarters and that there appeared to be strong momentum in the economy even at the end of the first quarter.

Monthly GDP growth in March topped estimates at 0.6 percent from February. This suggests second-quarter growth may also be above expectations even though analysts expect the effects of government and central bank stimulus to fade somewhat in the second half of this year.

“We are of the view that much better-than-expected consumer spending and housing market performances so far this year came at the expense of future growth,” said economist Diana Petramala of TD Securities.

“The recent spending spree has left consumers even more fatigued and highly indebted than ever. As interest rates begin to rise and households have to devote a greater share of their income to servicing their debt, this may well constrain future consumer spending growth,” she said.

The Bank of Canada projects second-quarter growth of 3.8 percent.

Reporting by Louise Egan; Editing by Padraic Cassidy and Peter Galloway

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