Slower economic expansion upon us

Slower economic expansion is upon us judging by data released Friday that indicated U.S. GDP posted its weakest pace of three-month growth in nearly a year, while Canada eked out a modest gain in May as oil and gas exploration offset a widespread slump in real estate.

The results indicate the strong gains witnessed during the early stages of the recovery are definitely behind us. The worry now is whether growth can continue as governments wind down their respective stimulus measures that helped power the recovery.

“Economic momentum is ebbing,” said Benjamin Reitzes, economist at BMO Capital Markets, adding the soft Canadian data could prompt the Bank of Canada to rethink rate-hike plans for the rest of this year.

The Toronto stock market benchmark index and the Dow Jones industrial average shed roughly 100 points apiece shortly after opening on the weak economic data.

The U.S. economy expanded on an annualized basis in the second quarter by 2.4%, just short of market expectations. Much of the strength came from business investment in machinery and equipment, which surged 22% annualized, and a strong 28% gain in residential investment. This big gain was offset, however, by tepid 1.6% growth in personal consumption, which has been the main driver of the U.S economy.

Plus, net trade exerted a 2.8-percentage-point drag on U.S. GDP as the 10.3% gain in exports was outpaced by a 28.8% rise in imports.

“Overall, there is nothing here to change our core view that GDP growth would slow once the inventory rebound and fiscal stimulus fade,” said Paul Ashworth, Toronto-based senior U.S. economist with Capital Economics.

The data Friday also suggested the U.S. recession was deeper than previously expected. Revisions dating back to 2007 suggested the U.S. economy shrank 4.1% from late 2007 to the end of the second quarter of 2009, compared to a previously recorded 3.7% contraction.

Conversely, U.S. growth in the first quarter of 2010 was revised up to 3.7% from 2.7%.

Meanwhile in Canada, GDP in May posted a small month-over-month gain, 0.1%, after flat growth in April, with a 0.6% gain from the goods-producing sector -- powered by oil and gas extraction -- offsetting weakness in the housing sector.

So, on a three-month moving average, month-over-month economic growth has decelerated from a peak of 0.5% in March to just 0.2% in May.

As it happened, the Canadian Real Estate Association reported Friday morning it would revise downward its 2010 forecast for home sales activity, to 459,600 units or 1.2% less.

A slowdown in retail trade and housing-related sectors “is consistent with headwinds faced by an overindebted household sector, which will likely continue to put a damper on those industries directly related to consumer spending and the housing market in the coming months,” said Diana Petramala, economist with Toronto-Dominion Bank.

Canadian households have a debt-to-disposable income ratio of nearly 150%, or a record. Plus, tougher mortgage qualification rules introduced by Ottawa, and the emergence of the harmonized sales tax in Ontario and British Columbia have helped slow down real estate activity.

Mr. Reitzes said the May reading would suggest Canadian second-quarter growth is on track for a mid-2% annualized gain -- which would be below the Bank of Canada’s 3% expectation.

”While growth and inflation look poised to undershoot the Bank of Canada’s forecast, we continue to anticipate a rate hike in September, though a softening outlook will prompt a pause in the last two meetings of 2010,” Mr. Reitzes said, which would mean the central bank’s key policy rate would end 2010 at 1%.

(prepared by Paul Vieira/Financial Post)