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Some shoppers take a break in Toronto's Eaton Centre, as others swirl about them. Canada's economy is trending toward annualized growth of 2.5 per cent in the first quarter, but this growth rate could be difficult to replicate in the immediate future.Tibor Kolley/the Globe and Mail

After robust growth at the start of the year, the Canadian economy is losing momentum this spring as it contends with higher interest rates.

The jump in output in the early stages of 2023, which followed a stagnant fourth quarter of 2022, was thanks in part to unseasonably warm weather and strong labour demand. But the upturn appears to have been short-lived.

Real gross domestic product rose 0.1 per cent in February, after a 0.6-per-cent expansion in January, Statistics Canada said Friday in a report. In a preliminary estimate, the agency said GDP edged lower by 0.1 per cent in March.

All told, the economy is trending toward annualized growth of 2.5 per cent in the first quarter. This pace of growth is much stronger than forecasters had expected at this stage of the economic cycle, but it could be difficult to replicate in the immediate future.

The Bank of Canada has aggressively raised interest rates in a deliberate attempt to slow the economy and bring inflation under control. Its policy rate – now at 4.5 per cent, the highest since late 2007 – is expected to remain at elevated levels for some time.

Most private-sector forecasters believe Canada will enter a mild recession later this year as higher interest rates continue to weigh on economic activity. The outlook is further complicated by the fact that more than 100,000 federal public servants are on strike. The work stoppage has lasted into a second week, with little progress in negotiations.

“The weak end to the first quarter, combined with the negative but temporary impact of the public sector strike on Q2 GDP, increases the risk of a contraction in economic activity during the second quarter,” Andrew Grantham, senior economist at CIBC Capital Markets, said in a note to clients.

“However, the Bank of Canada will look through that volatility, and focus instead on trying to get and keep inflation and inflation expectations under control. While a weakening economy should prevent policymakers pulling the trigger on another interest rate hike, we don’t see cuts forthcoming until early next year.”

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Statscan divides the economy into 20 subsectors. In February, 12 of them had increases in GDP. The public sector – which includes education, health care and public administration – rose 0.2 per cent, for a 13th consecutive monthly increase. The strike puts that streak in jeopardy.

Output in the construction industry rose 0.3 per cent in February, matching the increase in finance and insurance.

By contrast, activity in wholesale trade fell 1.3 per cent during the month, while retail trade dropped by 0.5 per cent. According to Statscan’s estimates, those industries continued to decline in March, contributing to the overall contraction in output.

More than one year after the Bank of Canada started to raise interest rates, the economy has shown resilience. Companies are continuing to hire, and the unemployment rate (5 per cent) is just shy of a record low. Many households are continuing to spend freely, undeterred by lofty inflation and rising interest rates.

The Bank of Canada recently upgraded its GDP growth forecast for 2023 to 1.4 per cent from 1 per cent, to account for the early burst in activity.

But the central bank expects growth to be weak through the rest of the year. It can take time – 18 to 24 months – for rate hikes to fully transmit to the economy.

Bank of Canada officials considered raising interest rates this month, but ultimately chose to hold rates steady, according to a summary of deliberations that was published this week.

The annual inflation rate ebbed to 4.3 per cent in March, from a peak of more than 8 per cent in June, 2022. The central bank projects a further deceleration to around 3 per cent by the middle of the year.

Still, Bank of Canada officials have stressed that getting inflation back to their 2-per-cent target could prove challenging. Financial analysts have interpreted the bank’s recent communications as an indication that interest rates will not be lowered this year.

“Higher interest rates are slowing household spending, particularly on big-ticket items. As mortgages are renewed at higher rates, more households will feel the restraining effects of monetary policy,” Bank of Canada Governor Tiff Macklem explained during a recent news conference.

“Business investment is also expected to soften in the year ahead, dampened by weaker demand for Canadian exports and higher financing costs,” he said. “Taking these forces into consideration, we expect Canadian GDP growth to be weak for the rest of this year before beginning to pick up gradually through 2024 and through 2025.”

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