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Consumers May Keep Canada Contraction From Being a Recession

Household spending and business investment may help restart Canadian growth after the economy shrank in the second quarter, according to investors and economists.

Domestic spending accelerated from April to June, with gains in every major component, even as exports were disrupted by natural disasters and factory shutdowns, which led to the 0.4 percent annualized contraction reported yesterday by Statistics Canada. All 15 economists surveyed by Bloomberg after the data were released said they still expect the economy to expand in the third quarter, averting a recession.

“It’s going to be a bumpy ride, but we are going to be able to pull through,” said Arlene Kish, an economist at IHS Global Insight in Toronto. “As long as people focus on job growth, that’s going to limit any downtick in consumer confidence.”

Domestic strength has helped insulate Canada from weakness in demand coming from other Group of Seven countries since the 2008 financial crisis. Canada has also avoided bank collapses and posted the G-7’s smallest budget deficits, helping to support consumer and business confidence.

In the past half century, Canada has never posted back-to-back declines in quarterly output when domestic spending has risen, according to Statistics Canada data.

“As long as the domestic economy is continuing to grow, it’s often been the case that overall weakness in GDP doesn’t persist,” said Paul Ferley, assistant chief economist at Royal Bank of Canada in Toronto. Even the second-quarter drag from trade was linked to “transitory factors” that should reverse, he said.

Temporary Disruptions

Automobile production fell an annualized 6 percent in the quarter as Japan’s earthquake and tsunami disrupted supply chains. Production may rise later this year at companies such as Calgary-based Imperial Oil Ltd. after refinery shutdowns due to maintenance. Wildfires in Alberta in May also led oil producers such as Cenovus Energy Inc. of Calgary to cut output.

The currency rose 0.1 percent to 97.65 cents per U.S. dollar at 9:21 a.m. in Toronto from 97.77 cents yesterday, after being little changed following the Statistics Canada report. By contrast, the currency fell 1.2 percent to a three-month low in March 2009 when Statistics Canada reported the economy shrank at the end of 2008, marking the start of the last recession.

Final domestic demand, which excludes inventories, imports and exports, grew by 0.7 percent after a 0.5 percent increase in the first quarter, Statistics Canada said. Consumer and government spending both increased 0.4 percent, while fixed capital investment rose 2 percent.

‘Good Handoff’

The quarter ended with growth of 0.2 percent in June, the first gain in three months, led by retailing and oil and gas extraction.

“The good handoff from June suggests a rebound in the third quarter,” Krishen Rangasamy, senior economist at National Bank Financial, said in a telephone interview from Toronto. “Final domestic demand itself was very solid. In any other environment that would be supportive of Bank of Canada rate hikes.”

Mark Carney, head of Canada’s central bank, has kept his key lending rate at 1 percent since September. None of the 17 economists surveyed by Bloomberg Aug. 22 to Aug. 29 are predicting an increase at his next announcement Sept. 7. Carney told lawmakers Aug. 19 that investment and consumption will lead an economic recovery in the second half of this year. Carney also said economic “headwinds,” including the European debt crisis and the Canadian dollar’s rise against the U.S. dollar, had increased. The Canadian dollar touched 94.23 cents per U.S. dollar July 21, the strongest since November 2007.

Calls for Stimulus

The report led to renewed calls from opposition lawmakers for increased stimulus. Interim Liberal Party Leader Bob Rae said yesterday his party will focus on “jobs, jobs, jobs” when Parliament resumes Sept. 19, because Prime Minister Stephen Harper’s Conservatives are too concerned about cutting spending.

Finance Minister Jim Flaherty rejected that notion, telling reporters in Toronto “we have to stay the course” and maintain “our plan to return to balance to support our recovery.”

The labor market remains one of Canada’s biggest advantages, with unemployment falling to 7.2 percent in July from a peak of 8.7 percent in August 2009. In the U.S., lawmakers and Federal Reserve officials have debated adding new stimulus to tackle a jobless rate that has exceeded 8 percent since February 2009.

Scotia Capital economist Derek Holt, who forecast the contraction and who predicts no interest rate increases “for at least the next year or so,” said the rebound may be limited because Canadian companies will need to work off the large amounts of inventories they built up in the second quarter.

“The bigger question mark is what happens in the fourth quarter and first quarter of next year in terms of loss of momentum in the U.S. economy and how that further spills into Canada,” he said.

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