Canadian economy outperforms in January, keeping pressure on central bank

A Canadian dollar coin, commonly known as the "Loonie", is pictured in this illustration picture taken in Toronto

By Ismail Shakil and Steve Scherer

OTTAWA (Reuters) -The Canadian economy grew more than expected in January and is seen expanding further in February, data showed on Friday, results that are likely to fuel concern by the central bank that inflation has yet to be fully tamed.

The economy gained by 0.5% in January, ahead of analysts' forecasts of a 0.3% rise, after contracting 0.1% in December, Statistics Canada said. February gross domestic product likely increased 0.3%, Statscan said in a flash estimate.

"There were many indications that the economy got off to a solid start in 2023, but today's double-barrelled blast of strength is well above even the most optimistic views," Doug Porter, chief economist at BMO Capital Markets, said in a note.

"Suffice it to say that if the strength seen in the opening months of the year persists, the Bank of Canada is going to find itself in a tough spot."

The Bank of Canada became the first major central bank to pause interest rate hikes in March after increasing them at eight consecutive previous meetings. With the key overnight rate now at 4.5%, the bank said it would not raise rates again if inflation came down as forecast.

While inflation has eased, falling to 5.2% in February from a high of 8.1% last year, the economy is expanding faster than the central bank had forecast in January.

"The Bank of Canada had pencilled in a 0.5% annualized rise for Q1," Porter said, adding that today's results point to growth of "around 2.5%" in the first quarter.

The central bank's next policy decision, and its new forecasts, will be released on April 12.

Andrew Grantham, executive director at CIBC Capital Markets, said the strong growth figures suggest "the Bank of Canada will use its April meeting to reiterate that, despite the recent issues in the U.S. and European banking sectors, it is still prepared to raise interest rates again if needed."

Earlier this week, the central bank said it is ready to step in with support if the banking system comes under severe strain, but it is not even close to being worried about the health of the financial system at the moment.

The failures of U.S. lenders Silicon Valley Bank and Signature Bank, followed by Credit Suisse's rescue, are prompting central bankers to closely monitor the potential for banking stress to trigger a credit crunch.

Due to the banking stress and the restrictive effect on the economy, money markets expect the Bank of Canada's next rate move to be downward, but the bank has repeatedly said it sees an upside risk to inflation and is ready to hike again if needed.

Industries including wholesale trade and mining, quarrying, and oil and gas extraction rebounded in January from declines recorded in the previous month, Statscan said.

The service-producing sector grew by 0.6%, while goods-producing industries posted a 0.4% increase in January, the agency said.

In a preliminary estimate for February, Statscan said industries including mining, quarrying, and oil and gas extraction, and manufacturing likely recorded gains and helped offset decreases in construction and wholesale trade.

Canada's 2-year yield was up 2 basis points at 3.793%, while the Canadian dollar was trading 0.1% lower at 1.3532 to the greenback, or 73.90 U.S. cents, but holding near its strongest level in more than five weeks.

(Reporting by Ismail Shakil and Steve Scherer in Ottawa; additional reporting by Dale Smith in Ottawa and Fergal Smith in Toronto; editing by Jonathan Oatis)