UPDATE 5-Canada skirts recession in second quarter

 

(Adds poll results, updates currency)

By Louise Egan

OTTAWA, Aug 29 (Reuters) - Canada's economy narrowly avoided a recession in the second quarter but the tepid 0.3 percent annual growth rate raised doubts about how long the Bank of Canada could afford to keep interest rates on hold.

Gross domestic product shrank 0.8 percent in the first quarter, revised from the original estimate of a decline of 0.3 percent, as global demand waned for exports such as autos, forest products and machinery, Statistics Canada said on Friday.

The second-quarter figures were below general market expectations of 0.7 percent growth in real GDP.

But recent data had braced markets for a lower than expected growth number, or even a recession, which is commonly defined as two straight quarters of economic decline.

That would have produced a explosive political situation for Prime Minister Stephen Harper who has hinted he wants to call a general election as early as next week. The opposition Liberals immediately blamed Harper for "mismanagement" of the economy, resulting in "the worst two economic quarters in almost two decades."

A Reuters poll done after the GDP report on Friday showed 11 out of 12 primary securities dealers in Canada expect the central bank to hold rates steady next Wednesday.

"I think it will result in them just holding interest rates steady. They're also dealing with concerns about higher inflation pressures," said Paul Ferley, assistant chief economist at Royal Bank of Canada.

Added Sebastien Lavoie, economist at Laurentian Bank: "For the bank to lower rates, you'd need a deep recession."

Derek Holt and Karen Cordes at Scotia Capital disagreed.

"We now think the BoC cuts 25 basis points with the material risk of 50 basis points next Wednesday," they wrote in a research note.

"In our opinion, the BoC would have great difficulty explaining how a faster than expected deterioration in the economy would justify inaction for another month and a half until the next interest rate announcement in October."

Most dealers surveyed expect rates to stay at 3 percent through the end of the year, with nine of the 12 expecting the next move by the bank to come in the first half of 2009.

The Canadian dollar slid as the rate cut view took hold.

On Friday afternoon the currency was at C$1.0626 to the U.S. dollar, or 94.11 U.S. cents, down from C$1.0519, or 95.07 U.S. cents, at Thursday's close.  Continued...