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An employee at Baldor Electric Co. works inside the company's factory in St. Louis.

Jeff Roberson/The Globe and Mail

Canada's economy is being held back only by its trading partners.

The latest reading suggests the country struggled to recover from the recession in the third quarter. But behind the headline statistic, a sharp rebound in the domestic economy is under way.

Canada's GDP grew at an annual rate of just 0.4 per cent in July through September. That was much slower than the 1-per-cent median estimate of 19 analysts surveyed by Bloomberg News and the 2-per-cent annual pace anticipated by the Bank of Canada in October.

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But the third-quarter growth snapped three previous quarters of contraction. And a big driver was a thirst for imports, which surged at an annual rate of 36 per cent, the most in more than two decades, according to a report by Statistics Canada Monday.

Healthy imports are a telltale sign of a buoyant domestic economy, as consumers and businesses seek the goods and services they can't get at home. Increased shipments from abroad also suggest companies are taking advantage of the higher dollar to retool to become more productive.

That leaves exports as Canada's economic anchor.

With the global economy picking up, Canadian exports rose for the first time in more than two years in the third quarter - but only at half the pace of imports, suggesting U.S. consumers and businesses remain reluctant to spend after the worst financial crisis since the Great Depression.

""The surge in imports reflects Canadian domestic demand that is stronger than in the U.S.," said Yanick Desnoyers, assistant chief economist at Montreal-based National Bank Financial, which was one of the earliest firms to predict Canada's economy would resume growing in the third quarter. "The Bank of Canada will focus on domestic demand, not the GDP number."

Canada's exports of goods and services equal about 40 per cent of its $1.3-trillion economy, making the country one of the most dependent on trade among developed nations.

So even though the strength of domestic demand suggests economic stimulus is working, there's only so much Bank of Canada Governor Mark Carney, Finance Minister Jim Flaherty and a population of 33 million people can do on their own.

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The U.S. economy is showing signs of life, including a report Monday by the Institute for Supply Management that showed business activity in the Chicago area rose in November to its highest level since, August, 2008.

Still, the world's largest economy - and the buyer of more than 70 per cent of Canada exports - is expected to take at least a year to rebuild from the financial crisis.

For Canadian exporters, the effect of weaker demand from the U.S. will be exacerbated by the loonie's 16-per cent increase against the U.S. dollar, which will make Canadian goods more expensive.

"The Canadian dollar, it appears, will do fairly well," Anne Giardini, president of forestry company Weyerhaeuser Co.'s Canadian subsidiary, said on Business News Network Monday. "For Canadian businesses tied to the U.S., there will be some slogging, some tough work ahead to remain competitive."

There's a flip side to the stronger dollar: It makes the most innovative equipment and technology cheaper to buy.

The surge in imports in the third quarter was led by a 25-per-cent rise in automobile and parts, reflecting the emergence of General Motors and Chrysler from bankruptcy protection, a 10-per-cent increase in purchases of machinery and equipment, and a 5-per-cent gain in industrial goods.

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Over all, business investment in machinery and equipment grew 5.9 per cent, the first rise in five quarters, Statscan said.

"Companies are beginning to see demand pick up and that's certainly coming through the GDP numbers," said Jayson Myers, president of the Ottawa-based Canadian Manufacturers & Exporters. "They're making these investments now because they're realizing, as the economy begins to strengthen, they're going to have to, especially with the high dollar, compete more on the basis of automation, high technology and new product development, and go into new markets."

GDP rose 0.4 per cent in September alone after levelling off in July and August, as goods-producing industries expanded output for the first time since July, 2008. That showing suggests Canada's economy went into the final three months of the year with considerable momentum.

"I'm happy to say it's the best we've seen in a year," said Eric Melka, CEO of Markham, Ont.-based Redline Communications Inc., which develops and distributes wireless broadband equipment to providers in 130 countries. "Customers are coming back now, projects are starting again, and there's a loosening of purse strings globally."

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