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Economy Canadian economy disappoints, raises spectre of contraction

A construction worker in downtown Toronto.

MARK BLINCH/REUTERS

Canada's economy grew at its fastest pace in more than a year in the first quarter, but a deeper-than-expected slump in March has put the economy on a much weaker footing for what could be an outright contraction in the second quarter.

Statistics Canada reported Tuesday that real (i.e. inflation-adjusted) gross domestic product grew at an annualized rate of 2.4 per cent from the previous quarter, the fastest since the fourth quarter of 2014, and well ahead of the 0.5-per-cent pace in the final quarter of 2015. The 2015 fourth-quarter figure was revised downward from the originally reported 0.8 per cent.

Despite the solid growth, the first-quarter result was well below the 2.8 per cent average estimate of economists, and a far cry from forecasts of more than 3 per cent from just a few weeks ago, testament to the disappointingly weak finish to the quarter. March's real GDP was down 0.2 per cent month over month, even worse than the 0.1-per-cent decline economists had anticipated, marking the second straight month of contraction after a booming start to the year.

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"A fine quarter ended with a thud, as Canadian GDP got all its momentum from its first month, a signpost of a slowdown ahead," said Canadian Imperial Bank of Commerce chief economist Avery Shenfeld in a research note.

The loss of momentum, coupled with the Alberta wildfires, has economists expecting that the economy will stall in the second quarter. The weaker-than-expected first-quarter and March results now have many economists anticipating that the economy will shrink slightly in the current quarter.

"The quarter ran out of steam by March, and the worry is the start-of-year performance may prove a one-trick pony," said Leslie Preston, senior economist at Toronto-Dominion Bank, in a research note. "The disappointing monthly GDP reading in March means that economic momentum was already looking soft heading into the second quarter, and the disruption of oil production in the oil sands due to the Alberta wild fires will worsen what was already looking like a soft quarter."

The Canadian dollar weakened after the release of Tuesday's report. Around noon, the loonie was trading at 76.32 cents (U.S.), down from Monday's close of 76.62 cents.

For the first quarter, exports of goods and services led the growth, with a surge of 6.9 per cent annualized. Consumer demand was also solid, with household consumption up a healthy 2.3 per cent annualized.

The economy continued to suffer from slumping business investment, a major theme since the oil shock hit in late 2014. Business gross fixed capital formation – which reflects corporate spending on structures, machinery and equipment – fell 1.5 per cent annualized, the fifth straight quarter-to-quarter decline, although it was the smallest drop over that time. But excluding residential construction, which remained strong amid a healthy housing market, business investment was down 9.3 per cent annualized.

Economists also noted that businesses continued to whittle down their inventories, perhaps reflecting the unsteady growth in the U.S. and other export markets during the quarter. Inventory drawdowns subtracted about 0.3 percentage points from the annualized growth rate in the quarter.

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On an industry basis, the first-quarter growth was led by retail sales, up 6.4 per cent annualized from the previous quarter. Manufacturing was up 2 per cent annualized, while the oil and gas and mining segment also grew 2 per cent. The financial and real estate segments both grew at a 3.2-per-cent pace. Construction fell 1.6 per cent.

In March, the big drag on growth was from the beleaguered energy sector, which slumped 1.5 per cent month over month. A sharp drop in drilling activity sent oil and gas support services down 14 per cent in the month, while oil and gas extraction fell 0.8 per cent. The manufacturing sector dipped 0.2 per cent in March, adding to its 0.9-per-cent slowdown in February. And retail sales fell 1.3 per cent, reversing course after two straight months of gains.

Overall, output from goods-producing industries slumped 0.8 per cent in March, their worst performance in six months. Services-producing industries were flat for the second straight month.

"Today's GDP report is further evidence of the Bank of Canada's message that the adjustment to lower oil prices has been uneven," Ms. Preston said. "The underlying fragility of Canada's economy beneath this see-saw growth pattern will necessitate monetary policy to remain stimulative for quite some time. We don't expect the Bank of Canada to raise interest rates until 2018 at the earliest."

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