Canada's economy slows in 2nd quarter, shrinks in June

By Louise Egan

OTTAWA (Reuters) - Canada's economy shifted into lower gear in the second quarter and contracted in June for the first time in six months, hurt by a Quebec construction strike and flooding in Alberta.

Gross domestic product grew by 1.7 percent on an annualized basis in the quarter, Statistics Canada said on Friday. The growth was largely powered by consumer spending while business investment, inventories and exports dragged on growth.

The expansion slowed from a 2.2 percent clip in the first quarter, revised down from the 2.5 percent rate initially reported. Canada underperformed the United States, where growth accelerated to a 2.5 percent annual rate in the second quarter.

The lackluster performance was widely anticipated, with forecasters in a Reuters poll expecting growth of 1.5 percent and the Bank of Canada last month estimating a gloomier 1 percent gain.

But the details of the report may disappoint policy makers who have been hoping that corporate investment and stronger exports would take the baton from highly indebted consumers to do most of the heavy lifting in the economy.

"The big story here is that you see it is still very much a household driven economy right now," said Andrew Kelvin, senior fixed-income strategist at TD Securities.

"We see net exports were still a bit of a drag ... and business investment really hasn't taken off the way one might have hoped. ... From a longer-term perspective, I think we're very much on track for the recovery into the second half of the year," he said.

The Canadian dollar briefly touched a session low after the data to C$1.0559 to the U.S. dollar, before recovering to trade around C$1.0544. It closed on Thursday at C$1.0530.

For the month of June, GDP shrank 0.5 percent, as expected. A flood in the Western province of Alberta in June shut down oil industry capital Calgary for days and displaced over 100,000 residents. In Quebec, construction workers walked off the job for two weeks in June, the peak of the building season.

Construction activity declined 1.9 percent in the month as a result. Nonresidential construction plunged 7.3 percent in June.

The economic impact of the flood was less evident, with the weakness in June spread across several sectors and regions.

Most economists had expected a bigger shock from the floods, predicting that a sharp slowdown in the second quarter would give way to a big rebound in the third due to partly to rebuilding. The Bank of Canada's forecasts last month put third-quarter growth at a robust 3.8 percent.

The fresh data suggests less volatility in growth and possibly a milder third quarter than the central bank previously thought, said Paul Ferley, assistant chief economist at Royal Bank of Canada.

Barring other major setbacks in Canada and the United States, economists expect the Bank of Canada to begin raising interest rates in the fourth quarter of 2014.

"I think policy just remains on hold waiting for indications on how the third quarter is shaping up," Ferley said.

Other reports on Friday pointed to a stronger second half. The Macdonald-Laurier Institute, a think tank, reported a 0.4 percent rise in its composite leading indicator in July, and the Conference Board of Canada's consumer confidence index climbed 2.2 points in August on greater optimism about current and future finances.

POWER TO THE PEOPLE

In the second quarter overall, consumers powered much of Canada's growth. Consumer spending rose 0.9 percent, the strongest on a quarterly basis in 2-1/2 years because of car purchases and insurance claims after the Calgary flooding.

Investment in housing bounced back, rising 1.3 percent after three consecutive quarters of declines. Again, the government and central bank have been hoping the housing market would cool after a prolonged period of overheating.

Government spending contributed to growth to a lesser extent.

Exports, the economic engine that has yet to recover fully from the 2008-09 recession, edged up only 0.2 percent after 1.3 percent growth in the first quarter.

"It puts more uncertainty on the export component of GDP, which the Bank of Canada was really betting on giving us stronger growth in the second half," said Stefane Marion, chief economist at National Bank Financial.

(Additional reporting by Alex Paterson, Euan Rocha, Alastair Sharp and Julie Gordon; Editing by Jeffrey Hodgson and Leslie Adler)

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