Canada's economy turns sluggish as rate decision looms

By Louise Egan OTTAWA, May 30, (Reuters) - Canada's economy geared down at the start of the year, and not only because exports took a hit from bad weather in the United States, as business investment and imports also showed unexpected weakness. Growth slowed to 1.2 percent, annualized, in the first quarter from 2.7 percent in the final quarter of last year, according to Statistics Canada data released on Friday. The market forecast was for 1.8 percent economic growth. The report gives the Bank of Canada leeway to hold the line on interest rates even though inflation jumped back up to its 2 percent target in April for the first time in two years. Economists have laid some of the blame for the sluggish growth on an unusually harsh North American winter. The U.S. economy contracted by 1 percent in the first quarter. In Canada an ice storm caused the economy to shrink in December, and bad weather may have been behind weaker demand for Canadian exports from the United States. But weather doesn't explain a 7.2 percent decline in imports or a drop in business investment, said Jimmy Jean, an economist with Desjardins Capital Markets in Montreal. "There's not a whole lot of silver lining in this report," he said. "It's way beyond a simple weather story. There's a sign of malaise in this report that wasn't expected." Compared with the previous quarter, GDP grew 0.3 percent in the three-month period. In March it expanded by 0.1 percent, as expected. The Canadian dollar CAD-D4 slipped immediately after the report to C$1.0847 to the greenback, or 92.19 U.S. cents, compared with C$1.0836, or 92.28 U.S. cents, at Thursday's close. CONSUMERS SCALE BACK Household spending, which has paced the economy since the Great Recession of 2008-09, grew by 1.2 percent, annualized, in the quarter, about half the rate of the previous quarter. Also the transition toward growth led by exports and business investment, much desired by the central bank, did not materialize. Exports fell 2.4 percent in the quarter after five straight quarters of growth, but imports fell even more. Businesses did not pick up the slack, with investment falling 3.7 percent. In terms of industries, the biggest boost came from natural resources, with the mining and oil and gas extraction sector speeding up with 2.4 percent growth, non-annualized. Manufacturing, by comparison, edged up just 0.2 percent. Most economists expect a pickup in growth in the second quarter, piggy-backing on renewed strength in the United States. However, the Bank of Canada may want to emphasize the fragility of both the global and domestic economies in its rate statement on June 4, analysts said. The bank's mandate is to keep inflation at around 2 percent and with that target reached sooner than expected, it will be under pressure to justify holding its benchmark interest rate at a near-record low of 1.0 percent, where it has been for more than three years. "This report gives them a lot of good and powerful arguments to maintain their idea that downward inflation risks remain elevated, considering the fragility, and I think they're going to continue to allude to that," Jean said. (Reporting by Louise Egan and Alex Paterson; Editing by Chizu Nomiyama, Sofina Mirza-Reid and Peter Galloway)