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Dip in Canada's GDP chills rate hike talk

Economy shrank in February, underlining fragility of economic recovery

00:00 EDT Tuesday, May 01, 2012

OTTAWA -- A surprise dip in gross domestic product suggests the economy has less strength than Bank of Canada policy makers had thought, reducing market expectations for a summer interest-rate hike.

The economy shrank 0.2 per cent in February to an annualized $1.28-trillion, Statistics Canada said Monday, as factories posted their first drop in six months and mining activity plunged. The unexpected drop, after a 0.1-per-cent gain in January, suggests Bank of Canada Governor Mark Carney's projection of a 2.5-per-cent annual growth rate for the first quarter is too optimistic.

The main driver was a 7-per-cent drop in mining, as potash plunged 19 per cent. Plus, a Sudbury nickel mine that also produces copper and other metals closed in the early part of the month over safety issues, while oil and gas extraction fell 0.9 per cent due to shutdowns in Alberta.

However, total economic output would have contracted even without such a bad month for resources.

Manufacturing dropped 1.2 per cent, utilities fell 1.9 per cent as warmer weather reduced demand, and retail sales slipped for a second month - not a good omen in an economy where the central bank sees consumer spending making up more than half of all growth this year and next.

Most of the industries that flagged in February probably rebounded in March, economists said. But the slow start to the year indicates there is more slack in the economy than Mr. Carney and his policy team had started to think. Consequently, it may be longer before they can comfortably lift borrowing costs, with the effects of a high currency, a far-from-unsettled global backdrop, and the fact so many households are overstretched with debt, all arguing for caution.

"That's why when the Bank of Canada talked about the possibility of raising rates soon, we didn't really change our forecast," said Krishen Rangasamy, a senior economist at National Bank Financial in Montreal, which sees Mr. Carney staying on hold until 2013 despite his warnings in recent weeks that rate hikes might soon be needed to keep inflation in check.

"We thought, Europe is still a mess," Mr. Rangasamy continued, "and that, plus softer domestic demand, might prompt the central bank to delay rate hikes until next year."

Traders of securities tied to the future level of interest rates scaled back expectations Monday that the central bank could boost borrowing costs by September. The loonie also fell, by 0.7 per cent.

Still, even as Mr. Carney has stressed that the "timing and degree" of rate hikes will depend on domestic and external developments, he also sees debt accumulation as the No. 1 made-in-Canada risk to the economy. He may want to tighten borrowing costs sooner than later, just to give households a stark reminder that "low-for-long" does not mean "low forever."

Doug Porter, deputy chief economist at BMO Nesbitt Burns, said the report suggests the economy grew at an annual rate closer to 1.8 per cent in the first quarter, which means it could be tough for the central bank to realize its projection of 2.4-per-cent growth for all of 2012.

Indeed, the economy was 1.6-per-cent bigger in February than a year earlier, marking the slowest pace of annual growth in more than two years.

But even though Mr. Porter doesn't see the central bank hiking before early 2013, a lot could happen in the coming weeks to put the economy back on track for higher borrowing costs by the end of the year, possibly even this summer, he said.

"The Bank has sent a pretty strong message that they're not comfortable with rates at current levels," he said, "so they just need to be convinced that this was a one-month wonder and that the economy is back onto a 2-per-cent-plus growth track, to get them hiking."

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