Canada’s economy unexpectedly shrinks; central bank likely to hold rates

By Ismail Shakil and Steve Scherer

OTTAWA (Reuters) -Canada’s economy unexpectedly contracted in the second quarter at an annualized rate of 0.2% and growth was most likely flat in July, data showed on Friday, a result that will probably allow the central bank to hold rates amid a possible recession.

The second-quarter reading was far lower than the Bank of Canada’s (BoC’s) forecast for a 1.5% annualized GDP growth as well as the 1.2% gain expected by analysts. June gross domestic product declined 0.2% from May, in line with forecasts.

“The Canadian economy may already have fallen into a modest recession,” said Stephen Brown, deputy chief North American economist for Capital Economics. The figures “leave little doubt that the Bank of Canada will keep interest rates unchanged next week,” he said.

The quarterly slowdown was largely due to declines in housing investment and smaller inventory accumulation as well as slower international exports and household spending, Statistics Canada said.

In June, Canadian wildfires adversely impacted multiple industries, including mining and quarrying and rail transportation.

Friday’s GDP report is the last major piece of domestic data before the BoC makes its next policy decision on Wednesday. Thirty-one of 34 economists polled by Reuters between Aug. 24-30 expect no change to the central bank’s overnight rate at the meeting.

“It becomes easy for the bank to say, ‘monetary policy is continuing to work and it justifies an on-hold stance at this month’s meeting,'” said Andrew Kelvin, chief Canada strategist at TD Securities.

Money markets sharply trimmed bets for an interest rate increase next week, pricing in a 7% chance after the GDP figures were released compared with a 23% chance before.

The yield on Canada’s 2-year bond, which tends to be sensitive to the BoC rate outlook, eased 9.1 basis points to 4.555%. The 10-year rate was unchanged at 3.565%.

The Canadian dollar was trading 0.5% lower at 1.3574 to the greenback, or 73.67 U.S. cents, while also losing ground against all the other G10 currencies.

The central bank hiked its benchmark overnight rate to a 22-year-high of 5.0% in July, the tenth increase since March of last year. Inflation last year hit a four-decade high of 8.1%, four times the central bank’s 2% target.

Since then the bank has said its future moves would depend on its reading of the data, which have been mixed. Inflation surged more than expected in July to 3.3%, but the economy unexpectedly shed jobs in July and the jobless rate ticked up to 5.5%.

Statscan on Friday also downwardly revised May GDP to an increase of 0.2% from an initial report of 0.3% growth. First-quarter annualized growth rate was also downwardly revised to 2.6% from 3.1%.

“It looks as if growth is going to struggle to stay positive in the third quarter as well,” said Doug Porter, chief economist at BMO Capital Markets.

The high interest rate environment has coincided with falling housing investment, which recorded its fifth consecutive quarterly decrease in the three months ended in June.

The housing investment decline was led by a sharp drop in new construction as well as a fall in renovation activities, Statscan said.

(Reporting by Ismail Shakil and Steve Scherer; Additional reporting by Dale Smith, Fergal Smith and Nivedita Balu; Editing by Mark Porter)