Canada’s economy powered ahead in the first quarter by a stronger-than-expected rate of 3.8% on an annualized basis as consumers cranked up spending, increasing the chances of another interest rate hike by the Bank of Canada.

The growth rate, up from 2.5% in the fourth quarter of 2005, beat the average forecast of 3.0% in a Reuters poll, thanks to Canadians’ heavy purchases of durable goods like clothing and furniture, Statistics Canada said.

“The big surprise is on the consumption side, personal consumption is much stronger than anticipated,” said Carlos Leitao, chief economist at Laurentian Bank in Montreal.

A 3.4% jump in residential housing investment, which is the strongest quarterly advance in more than two years, also helped drive the expansion of gross domestic product.

The spending frenzy could lead the Bank of Canada to rethink its message put forth last Wednesday that it would likely refrain from hiking its benchmark interest rate further after seven consecutive increases to 4.25%.

“It raises the risk of the Bank of Canada extending its tightening cycle. But I think a lot will come down to second-quarter numbers,” said Sal Guatieri, senior economist at Bank of Montreal in Toronto.

The bank’s next policy announcement date is July 11.

The Canadian dollar, which had risen to 28-year peaks against the greenback prior to the data, edged back slightly as the US currency recovered ground. The greenback rose on expectations of more US rate hikes by the Federal Reserve. Canadian bonds fell across the board.

Tale of two economies

Statscan said the domestic economy grew 0.9% in January-March compared with the previous quarter.

Economists had expected weak foreign trade to have a bigger negative impact on the quarterly GDP but the domestic demand offset the stalling exports.

Exporters were battered by a rise in the Canadian dollar combined with a drop in foreign demand for motor vehicles, explaining the paltry 0.1 percent quarterly growth in manufacturing output.

Some manufacturers have demanded the Bank of Canada or the government take action to stabilize the strengthening currency, but Trade Minister David Emerson said on Wednesday that government had no place in the foreign exchange market.

“I think the matters regarding the dollar are the mandate of the Bank of Canada and they’re doing a good job,” he told reporters.

Imports were down slightly because of a drop in energy products imports.

“You get these two stories of still fairly moderate levels of interest spurring on the interest-sensitive components of consumption and housing and the rise in the dollar posing some challenges to the trade side, but not that bleak really,” said Don Drummond, chief economist at Toronto-Dominion Bank.

Monthly growth in March came in below expectations at 0.1%, compared with 0.3% in February. That could signal the start of a slowdown extending into the second quarter but economists say they expect no dramatic slide.

“It could well be that domestic demand is more than going to make up for the weakness in trade, and inventories are also likely to be positive,” said John Anania, assistant chief economist at Royal Bank of Canada in Toronto.

Inflation also appears to be well-capped as economy-wide prices as measured by the implicit price index for GDP, fell 0.7% in the quarter on declining energy prices. The index had risen in at least the previous five quarters. (Reuters)