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Canada's economy grew at weaker-than-expected pace in Q1, raising odds of June BoC cut

Statistics Canada is set to release its November gross domestic product report this morning, along with a preliminary estimate for economic growth in the fourth quarter. The Bay Street Financial District is shown with the Canadian flag in Toronto on Friday, August 5, 2022.THE CANADIAN PRESS/Nathan Denette
Statistics Canada is set to release its March gross domestic product report this morning. (THE CANADIAN PRESS/Nathan Denette) (The Canadian Press)

Canada’s economy grew at a slower pace in the first quarter of the year than economists and the Bank of Canada expected, increasing the possibility that the central bank will cut its benchmark interest rate next week.

Statistics Canada said real gross domestic product (GDP) grew 1.7 per cent at an annualized rate in the first quarter of the year, weaker than the 2.2 per cent that economists expected and short of the Bank of Canada's forecast of 2.8 per cent. In the first quarter the economy grew 0.4 per cent. Fourth-quarter GDP growth was also revised down, from an annualized rate of 1 per cent to 0.1 per cent.

Statistics Canada said in a release that higher household spending on services was a top contributor to the growth in the first quarter, offset by slower inventory accumulations.

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Canada’s economy showed no growth in March, following a 0.2 per cent increase in February. Advanced estimates show GDP grew 0.3 per cent in April, due to increases in manufacturing, mining, and quarrying.

The data comes days before the Bank of Canada is set to make an interest rate announcement that could see the central bank cut rates for the first time since early in the COVID-19 pandemic.

"While the downside surprise in Q1 was driven by a big cut in business inventories, the reality is that underlying growth remains well short of potential, and slack is building for the overall economy," BMO chief economist Douglas Porter wrote in a research note on Friday reacting to the data.

"For the Bank of Canada, we believe the main message is that the output gap is widening, as reinforced by a less-tight job market, modestly increasing the chances of a rate cut next week. There are respectable arguments on both sides of the decision, but we believe the balance of evidence points to a cut."

Money markets increased bets for a rate cut in June, from 66 per cent before the data was released to almost 80 per cent, according to Reuters.

"Given the weaker trend in GDP, and the cooling in inflation, the Bank of Canada remains on track to deliver the first interest rate cut at next week's meeting," CIBC economist Katherine Judge wrote in a research note.

"The Q1 figure was well below the Bank of Canada's last published MPR forecast (2.8 per cent), and activity looks even more sluggish when accounting for population growth, as the surge in domestic demand looks to be a one-off in the broader trend of weak readings seen last year."

While the report missed expectations, Desjardins' senior director of Canadian economics Randall Bartlett noted "the details of the release were more positive than the headline suggests."

Household spending increased 0.7 per cent in the first quarter due to a rise in services spending. The household savings rate also hit seven per cent in the quarter, the highest rate since Q1 of 2022. Business investment rose 0.8 per cent, driven by more spending on engineering structures largely within the oil and gas industry. At the same time, Statistics Canada noted widespread slowdown in business investment in inventories, with the retail auto industry posting the largest deceleration.

"While headline real GDP growth looks as though it will be respectable in the first half of this year, it will be notably below the pace recently forecasted by the Bank of Canada," Bartlett wrote.

"When combined with still-weak survey data and elevated business bankruptcies, we're still of the view that the Bank is likely to begin cutting interest rates at its upcoming June meeting."

Alicja Siekierska is a senior reporter at Yahoo Finance Canada. Follow her on Twitter @alicjawithaj.

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