UPDATE 2-Canada's growth beats expectations in May, rates set to stay low

Thu Jul 31, 2014 11:10am EDT

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By David Ljunggren

OTTAWA, July 31 (Reuters) - Canada's economy grew more than expected in May, expanding for a fifth consecutive month, but most likely not enough to persuade the Bank of Canada to raise interest rates.

Statistics Canada said on Thursday that gross domestic product (GDP) grew by 0.4 percent in May from April, more than the 0.3 percent forecast by market analysts. Year-over-year growth was 2.3 percent in May, up from 2.1 percent in April.

Canada's economy has grown sluggishly in recent months and the Bank of Canada - which has kept interest rates at near record lows since September 2010 - says there is no chance it will alter its neutral policy stance and opt for a rate hike until it sees evidence of sustained growth and higher inflation.

Central bank Governor Stephen Poloz said earlier this month the economy did not yet have enough steam to grow without the bank's help and said it could just as easily cut rates as raise them.

"Governor Poloz does not want to be fooled by a false start on the economic underlying trend before shifting its guidance," said Sebastien Lavoie, assistant chief economist at Laurentian Bank Securities.

"Consequently, this respectable ... GDP number will not be enough to move the Bank of Canada away from its firm neutral stance," he said in a note to clients.

The output of service industries increased by 0.4 percent in May on broad growth across most subsectors, while goods-producing industries rose 0.5 percent on strength in manufacturing as well as mining and oil and gas extraction.

Economists said the May data, which offset weak month-on-month GDP expansion of 0.1 percent in April, puts the economy back on track to grow by an annualized 2.5 percent in the second quarter, in line with the Bank of Canada's latest forecast.

In its July 16 Monetary Policy Report, the bank said third quarter growth would dip to 2.3 percent, down from the 2.6 percent it had expected earlier in the year.

"Since the Bank of Canada has already taken this rebound into account, however, it shouldn't change its neutral interest rate bias," said David Madani, an economist specializing in Canada at Capital Economics.

Manufacturing grew by 0.8 percent, pushed up by a 13.5 percent increase in motor vehicle production as some auto plants returned to full production after shutdowns.

Canada sends 75 percent of its exports to the United States, which on Wednesday reported the economy rebounded sharply in the second quarter.

David Tulk, the chief Canada macro strategist at TD Securities, said increased U.S. economic strength could mean higher than expected GDP growth in Canada.

"In this scenario the (Bank of Canada's) communications challenge to remain cautious in the face of a strengthening outlook becomes that much more difficult, creating an opportunity for the market to question the 'neutrality' of forward-looking language," he said in a note to clients.

(Reporting by David Ljunggren; Editing by Paul Simao and Peter Galloway)

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