May 30, 2008 / 1:13 PM / 11 years ago

UPDATE 3-Canada economy shrinks unexpectedly in 1st quarter

(Adds details and reaction)

By Randall Palmer

OTTAWA, May 30 (Reuters) - Canada’s economy shrank unexpectedly in the first quarter for the first time in five years, contracting by an annualized 0.3 percent and leaving open the possibility of additional interest rate cuts.

Widespread cuts in manufacturing, most notably in motor vehicles, were the leading reason for the economic decline, Statistics Canada said on Friday. The news drove the Canadian dollar lower as analysts had, on average, expected annualized growth of 0.3 percent.

The last time the economy shrank was in the second quarter of 2003.

“As far as monetary policy is concerned, it leaves the door wide open for at least one more (interest rate) cut by the Bank of Canada,” said Matthew Strauss, senior currency strategist for RBC Capital Markets.

“Whether it is in June or July remains to be seen.”

The Bank of Canada next sets interest rates on June 10 and then on July 15.

However, the decline in inflation-adjusted GDP may not tell the whole story, since strong energy prices — stripped out of the real GDP numbers — have actually brought large inflows of cash into Canada.

Nominal GDP grew at an annualized rate of 4.6 percent and Doug Porter at BMO Capital Markets said real income rose at an annualized rate of 2.4 percent.

“I don’t think things are nearly as dire as the GDP numbers suggest,” he said, noting that it measures the physical volume of output produced but ignores shifts in terms of trade — increases in export prices relative to import prices.

“Does anybody look at what Saudi Arabia’s real GDP is doing right now? Nobody cares. Everybody knows that Saudi Arabia is much better off than they were a year ago because of what oil prices have done, and Canada is in a more-or-less similar situation.”

Nonetheless, GDP numbers can have an impact on everything from foreign exchange markets to political discourse and central bank policy.

The Canadian dollar fell to US$1.0045, valuing a U.S. dollar at 99.54 Canadian cents CAD=, from US$1.0110, or 98.91 Canadian cents, at Thursday's close.

Statscan said GDP declined 0.2 percent in March, after a decline of 0.3 percent in February (revised from 0.2 percent) and a 0.6 percent rise in January.

The government agency said the economy started to lose momentum in the second half of 2007 as exports declined. It “stalled in the first quarter due to widespread cutbacks in manufacturing, most notably in motor vehicles.” A reduction in inventory accumulation was a major factor, Statscan added.

Canada is to a certain extent a tale of two countries, with thriving oil and gas-led activity in several regions and harder times in the populous manufacturing provinces of Ontario and Quebec, where companies must try to cope with last year’s sudden appreciation of the Canadian dollar.

“What people need to be worried about now is that Canada may be experiencing a mild recession here, with two negative quarters,” said Ted Carmichael, chief economist at JP Morgan Canada, looking ahead to the possibility that the economy might contract in the current quarter too.

“The economy here has not only ground to a halt, but is contracting. It’s weaker than the U.S. economy, which I think is probably a surprise to a lot of people.”

The U.S. economy showed real GDP growth of 0.9 percent in the first quarter.

In a separate release, Statistics Canada said higher oil prices pushed price indexes for raw materials and manufactured goods to record levels in April. Factory prices rose 1.4 percent from March. Raw materials were up 5.1 percent after March’s 6.7 percent hike, and now stood 23.0 percent higher than in April 2007. (Additional reporting by John McCrank; Editing by Peter Galloway)

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