Canada’s economy went into a tailspin at the end of 2007 as exports to the United States waned, strengthening the chance of an aggressive interest rate cut by the Bank of Canada.

Deteriorating exports caused gross domestic product to shrink 0.7% in December, against market forecasts of a 0.2% decline, a Statistics Canada report showed on Monday.

The economy grew just 0.8% on an annualized basis in the fourth quarter, slowing considerably from 3% in the third quarter to its most sluggish pace of growth since the second quarter of 2003.

Quarter-on-quarter, growth moderated to 0.2% from 0.7% in the previous quarter.

“It does seem that the weakness in the US economy has spilled over into Canada, and that this will certainly increase expectations for a 50-basis-point cut tomorrow as opposed to a 25-point cut,” said David Powell, currency analyst at IDEAglobal.

The data knocked the Canadian dollar to its lowest level in nearly a week. The currency was at US$1.0127, valuing a US dollar at 98.75 Canadian cents, down from US$1.0159, valuing a US dollar at 98.43 Canadian cents, before the report was released.

The Bank of Canada has already signaled it will cut its overnight interest rate when it meets to decide monetary policy on Tuesday, but economists are divided over the magnitude of the cut.

The central bank hasn’t slashed rates by more than a quarter percentage point since late 2001, but Governor Mark Carney is expected to be torn because of the contrast between a slump in Canada’s net trade position and surprisingly robust consumer spending.

The central bank reduced borrowing costs by a quarter point in December 2007 and again in January. Carney has said the degree of the next cut would depend on the data.

Exports fell 2.2% in the quarter, the first drop in six quarters, as the stronger Canadian dollar made Canada-made goods more expensive abroad and cheapened imports. Extended holiday shutdowns by car manufacturers also contributed to drooping sales to the United States, Statscan said.

Consumer spending, on the other hand, was the top contributor to growth, jumping 1.8%. Output by the services industry climbed 0.7% while goods-producing industries shrank by 0.9%.

“The break-down of fourth-quarter GDP greatly complicates the bank’s decision—while net exports are faltering badly, domestic spending is on fire, and rate cuts will simply add to the flames,” said Doug Porter, deputy chief economist at BMO Capital Markets.

In 2007 as a whole, GDP grew 2.7%, down slightly from 2.8% in 2006. (Reuters)