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Construction crews work at the site of a new housing development near Ottawa. (Sean Kilpatrick for The Globe and Mail)
Construction crews work at the site of a new housing development near Ottawa. (Sean Kilpatrick for The Globe and Mail)

Canada's recovery rests on shaky global economy Add to ...

A series of speed bumps stalled the Canadian recovery in April and May, underscoring the economy's vulnerability to shocks like the U.S. and European debt crises.

Gross domestic product fell by 0.3 per cent in May after flat-lining the month before, Statistics Canada said Friday, as everything from the aftermath of Japan's earthquake to high gas prices, wildfires and bad weather caused the economy to shrink for the first time since February. The drop was the sharpest since May, 2009, when the U.S. economy, Canada's principal export market, was still in the grip of its worst downturn since the Great Depression.

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Economists don't see the economy's subpar performance this spring as a tipping point toward a new recession, with most predicting a pickup through the rest of the year. But Friday's report raises questions about the strength of that pickup, particularly given the soft U.S. economy and the delicate dramas on either side of the Atlantic.

Before Friday, even the most pessimistic estimates for the annual rate of Canadian growth in the second quarter were still higher than 1 per cent. In response to the May number, economists hurried to revise their second-quarter estimates to as low as 0.5 per cent. That suggests the recovery can ill afford a big hit to confidence among investors, companies and households on either side of the Canada-U.S. border.

"If you've got an economy that's showing sluggish growth, you're vulnerable to a negative shock," Paul Ferley, assistant chief economist with Royal Bank of Canada, said in an interview. "Certainly, the budget discussions right now (in the United States) raise some concerns about whether you're seeing that kind of negative shock manifest itself." Mr. Ferley believes U.S. politicians will find a way to avoid the catastrophe that President Barack Obama and U.S. Federal Reserve Board Chairman Ben Bernanke have warned could occur if lawmakers prove unable to reach a deal in their debt fight this weekend or early next week.

Unlike the European situation, which involves multiple debt-strapped governments needing cash infusions from third parties just to fund basic operations, Mr. Ferley pointed out that the U.S. crisis is a risk but really amounts to a question of political will, not of the government's solvency.

Moreover, he said, most of the dismal showing in May was due to temporary, even one-off circumstances. Wildfires in northern Alberta and maintenance shutdowns pushed the mining, oil and gas sector - a reliable source of strength for much of the recovery - to its steepest decline since 1993. Construction fell as poor weather delayed projects, and manufacturing was hobbled as Japan's natural disasters continued to wreak havoc on North American auto production.

The fleeting nature of those factors and the fact that the economy churned out a solid 28,000 jobs in June suggest the weakness earlier in the spring wasn't "fundamental" and, therefore, probably didn't carry into the second half of the year, economists said Friday.

However, July employment reports for Canada and the United States, both set for release next Friday, will indicate how much the stream of negative news is already spooking the private-sector executives whose decisions will be crucial in ensuring that that's the case.

Earlier this month, the Bank of Canada's summer survey of businesses across the country found most plan to add staff in the second half of 2011. But the poll was conducted before the U.S. and European debt crises worsened, and well before a report Friday showed that the world's biggest economy grew at a 1.3 per cent annual rate in the second quarter, nowhere near enough to reduce unemployment, after a practically invisible 0.4-per-cent gain in the first quarter.

In the second quarter, consumer spending - the lifeblood of the U.S. economy and of the Canadian manufacturers who export into that market - rose a paltry 0.1 per cent.

"There's just so many questions, and it's dogging investor confidence," Emanuella Enenajor, an economist with CIBC World Markets Inc., said in Toronto. "If we see good jobs numbers in Canada and the U.S. next week, that would definitely reassure investors and the people who are responsible for making hiring and investment decisions, which is extremely important. But until we get some good data, I think there's still going to be a little of that hesitation prevailing."

Follow on Twitter: @jeremytorobin

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