The Canadian Press - Sept. 28, 2010

OTTAWA — Canada's almost year-long record of uninterrupted growth has likely suffered its first setback, with analysts anticipating that fresh data being released Thursday will show the economy actually got smaller in July.

The news may come as a surprise to many Canadians who are constantly reminded by the government that their economy is among the strongest in the industrialized world, especially when compared with the United States. That is one reality. But lately, the Canadian situation hasn't been much to boast about.

The economy burst out of the gate in the first three months of 2010 with a 5.8 per cent growth rate, then came back to earth in the second quarter at two per cent and is expected to be even weaker in this current third quarter.

July, the first month of the third quarter, will in all likelihood be the weakest, according to a consensus of economists sampled by Bloomberg. They believe gross domestic product actually fell back 0.1 per cent that month. TD Bank chief economist Craig Alexander thinks the pull-back was worse, as much as a 0.2 per cent drop in GDP.

There is no mystery why. He points out that housing market cooled in July, retail sales contracted, as did manufacturing shipments, wholesale sales and, most importantly, employment shrank by 9,000 total, and by 139,000 in full-time workers.

The bigger question is what does it mean? Is the retreat a foretaste of even tougher times ahead as governments, particularly Ottawa, start withdrawing stimulus and the Bank of Canada's recent interest rate hikes kick in? That's one possibility. But at the moment most analysts are betting the current weakness is, in part, pay-back for the fast early start of the recovery, along with a few temporary circumstances.

"There's very little chance of a double-dip recession in the Canadian economy unless the U.S. economy goes into recession, so I don't think the weakness in July is going to be accompanied by a future string of monthly contractions," said the TD's Alexander.  He notes that July was unusual in that it was the month that Ontario and British Columbia, two large economies, introduced the harmonized sales tax. As well, Nova Scotia raised its HST by two percentage points.

Analysts believe consumers used the knowledge to push forward purchases before July, particularly homes and house-related products, and took a time out in July. That means June's 0.2 per cent GDP advance was artificially high, while July's will be artificially low.  Even so, the economy is weak enough that the consensus now sees Bank of Canada governor Mark Carney refraining from further monetary tightening, possibly until next spring.

Forecaster Michael Burt of the Ottawa-based Conference Board says Canadians may be disappointed in the current stall, but shouldn't be surprised.  The disappointment is compounded by the fact the economy sizzled coming out of recession. It couldn't last, but even economists were surprised at how quickly the brakes have been applied.

"What was exceptional was the rebound we saw six months ago, not what we're seeing now. Historically, when you experience a financial crisis you don't see a sharp rebound and that's because banks and consumers are repairing their balance sheets," Burt explained.

Combine that with the economy's heavy weighting on exports -- which will be anemic as long as the U.S. stumbles -- and the result is "we'll be in for a long period of below average growth," he predicts.  CIBC chief economist Avery Shenfeld agrees with the modest outlook, but cautions against too much pessimism.

Canada remains in a far stronger position than the U.S. or most of Europe, although the GDP numbers don't reflect that at present. Growth rates can be misleading because they record changes from a base number, not the relative strength of the base.  Canada's economy is virtually where it was prior to the recession, with GDP having caught up to its pre-slump level and all the lost jobs -- over 400,000 -- having already been recouped. As well, house prices are relatively high, meaning household wealth has not collapsed.

By comparison, the U.S. is still seven million jobs shy of where it was prior to the recession and the housing sector, both in terms of prices and starts, is still near the recession's trough.  "Slowing to sub-par growth is not a disaster for us, but it is a disaster in the United States," said economist Sal Guatieri of BMO Capital Markets.

And that is being reflected in confidence ratings. The Conference Board in the New York said Tuesday it's consumer confidence index dropped more than expected to 48.5 in September, the lowest it's been since February and down from a revised 53.2 in August.

Canada's Conference Board releases its survey Wednesday morning, but recent readings have been consistently more positive than those in the U.S.