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The Canadian economy stumbled in the first quarter of the year, tripped up by weakness in consumer spending and housing markets, but a solid finish to the quarter has spurred optimism that the economy is headed into better times.

Statistics Canada reported on Thursday that real gross domestic product rose at a seasonally adjusted pace of 1.3 per cent annualized in the first three months of the year, the slowest quarter in nearly two years. It was the third consecutive quarter that the economy grew at less than a 2-per-cent rate, a considerable moderation from the nearly 4-per-cent average in the four quarters before that.

Residential investment slumped 7.2 per cent annualized in the quarter, reflecting the slowdown in the housing sector after the implementation of stricter federal mortgage regulations. Household final consumption spending grew a tepid 1.1 per cent, its slowest in three years. On the other hand, non-residential business investment – an important component for future economic growth potential – surged nearly 11 per cent annualized, its best quarter in a year.

While the result disappointed economists, they noted that the quarter finished strong, with March GDP up 0.3 per cent month over month, building on February’s 0.4-per-cent rise. This implies the economy entered the second quarter with stronger momentum, prompting several economists to raise their second-quarter forecasts.

“While the headline quarterly GDP result was a bit disappointing … the recent robust monthly readings and the strength in business investment provide a nice counterweight,” Douglas Porter, chief economist at Bank of Montreal, said in a note to clients.

Economists had grown optimistic in recent weeks that first-quarter growth would be significantly stronger, based on a string of economic indicators that suggested the economy had picked up as the quarter wore on. Just a day before the GDP numbers were released, the Bank of Canada said it believed first-quarter growth “appears to have been a little stronger” than the central bank’s formal estimate of 1.3 per cent, issued in its quarterly economic projections in mid-April. The consensus estimate among private-sector economists was 1.8 per cent.



The disappointment was reflected in the currency market, where the Canadian dollar fell four-tenths of a cent against its U.S. counterpart in the hour after the GDP news – although the currency was also hurt by concerns over the U.S. decision to impose steel and aluminum tariffs on Canada and other countries.

The market reaction reflected concerns that the first-quarter GDP result could reduce the likelihood of a Bank of Canada interest-rate increase in the near term. In its rate-decision announcement on Wednesday, the central bank hinted strongly that it is leaning toward a rate increase at its next decision in July – based partly on its belief that growth was ahead of the bank’s target in the early months of the year.

But in a news conference after a speech in Quebec City, Bank of Canada deputy governor Sylvain Leduc indicated the central bank was quite satisfied with the GDP report.

“The data has been really encouraging,” Mr. Leduc said. “What we’ve seen today, in terms of the [GDP] numbers, are really reassuring for us, reinforcing our views that the economy is evolving as expected.”

Bank of Nova Scotia economist Derek Holt suggested the markets may have overreacted to the lower-than-expected headline GDP number for the quarter, while overlooking the more positive details.

“The incrementally stronger rebound evidence in March, following February’s solid growth, is encouraging,” he said in a research note. “This plays to the narrative of a rebound from transitory softness at the start of the year that distorted the quarter.”

In particular, the economy suffered from transportation backlogs early in the quarter that have cleared up, economists noted.

While trade was a net negative in the quarter, subtracting 0.3 percentage points from GDP growth, economists said this was largely owing to rising imports – evidence of improved domestic demand and the strong business investment. They also suggested a decline in inventories, which also weighed on GDP in the quarter, will likely reverse itself when businesses replenish their stocks.

Economists now think second-quarter GDP growth could exceed the Bank of Canada’s forecast of 2.5 per cent annualized.

“Even the weak spots in today’s report shouldn’t last,” Toronto-Dominion Bank senior economist Brian DePratto said in a research report. “The bottom line is that the Canadian economy clearly still has some gas left in the tank.”