May 30 (Bloomberg) -- Canada's economy unexpectedly shrank in the first quarter, dragged down by lower automobile exports, giving the Bank of Canada more reason to cut borrowing costs again next month.

Gross domestic product contracted at a 0.3 percent annualized rate in the first quarter to C$1.33 trillion ($1.34 trillion), the first drop in almost five years, Statistics Canada said today in Ottawa. Economists surveyed by Bloomberg said the growth rate would slow to 0.4 percent from 0.8 percent in the fourth quarter. None of the 22 predicted a contraction.

The Canadian dollar fell as investors increased bets the central bank will ease a fifth consecutive time on June 10. Bank of Canada Governor Mark Carney cut rates by half a point last month and said more action was likely needed because an export slump would bring the slowest growth since the last recession in 1992.

The report was ``surprisingly ugly,'' said Derek Holt, an economist at Scotia Capital Inc. in Toronto. ``This cements at least a quarter point cut at the June 10 meeting.''

The currency weakened 0.5 percent to 99.29 cents per U.S. dollar at 11:20 a.m. in Toronto, from yesterday's 98.77 cents.

Falling automobile production caused a 3 percent drop in manufacturing in the first quarter and a 1.1 percent decline in exports, Statistics Canada said. Almost all of Canada's automobile production is shipped to the U.S., and excluding car and truck production and related industries the economy would have grown in the first quarter, the statistics agency said.

Changing Forecasts

Benoit Durocher, an economist at Mouvement Desjardins in Montreal, said the weak report led him to change his forecast for the next Bank of Canada rate decision to a half point cut from an earlier forecast of a quarter point reduction. The central bank's benchmark interest rate is 3 percent.

``The risk of not lowering rates is greater than that of lowering them. The numbers provide ample justification for lowering rates,'' Durocher said in an interview.

Exporters have been hurt by weaker U.S. consumer demand after the subprime mortgage market collapsed last year, and by the Canadian dollar's appreciation to a record. The U.S. economy, benefiting from a weaker currency, grew 0.9 percent in the first quarter on exports to countries such as Canada.

General Motors Corp. said April 28 it's cutting production of 138,000 large pickup trucks and sport-utility vehicles this year at four plants in the U.S. and Canada.

GM, the world's largest automaker, Ford Motor Co. and Chrysler have shed 36 percent of their workforce in Ontario, Canada's automaking center, in the past five years as they struggle with higher labor costs and surging fuel prices.

Domestic Demand

Canadian domestic demand also ebbed in the first quarter. Household spending slowed to 0.8 percent from 1.8 percent over the prior three-month span, as consumers spent less on services linked to foreign travel.

Imports fell 2.6 percent in the quarter, the first decline since the fourth quarter of 2006, spread among miscellaneous consumer goods, cars and machinery.

Businesses added C$3.42 billion to their inventories in the first quarter, compared with C$20.6 billion between October and December.

``It's hard to look for signs of strength'' in today's report, said Jacqui Douglas, an economics strategist at TD Securities in Toronto. ``A rate cut on June 10 is all but certain now,'' said Douglas, who predicts a quarter-point reduction.

Monthly GDP

On a monthly basis, the economy shrank 0.2 percent in March after a revised 0.3 percent decline in February, the first back-to-back monthly drops since March and April of 2003. Economists forecast growth would be little changed.

Canada is the world's eighth biggest economy. First- quarter growth was slower than the 1 percent pace the Bank of Canada predicted last month. For all of 2008, the central bank predicts a 1.4 percent expansion, the slowest since 1992.

Separately, Statistics Canada today said manufacturing product prices and raw-material costs rose in April, led by energy.

The industrial product price index rose 1.4 percent, while raw-material costs for factories rose 5.1 percent. Economists expected product prices to increase 1 percent, and input costs to increase by 2.8 percent, according to the median estimates in Bloomberg surveys.

To contact the reporter on this story: Greg Quinn in Ottawa at gquinn1@bloomberg.net.

Last Updated: May 30, 2008 11:24 EDT