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TODD KOROL/Todd Korol/Reuters

Canada's economy is slowing down sharply, ushering in a new phase of tepid growth that could last for years.

The 2-per-cent pace of expansion for the second quarter, reported Tuesday by Statistics Canada, gives the central bank more flexibility to hold off on interest rate increases in the months to come. The growth rate, which compares with a 5.8-per-cent clip in the previous three months, was slower than even the most pessimistic estimates, and reflects a widening gap between the country's imports and its sales abroad, as well as slower spending by consumers and governments.

Canada is likely settling in for a long, underwhelming stretch, rather than taking a nosedive back into recession. The scenario policymakers and economists have been warning about for months is now playing out: households are rebuilding savings, companies are still investing cautiously, and governments are retrenching after showering their economies with billions in stimulus money to ward off a deeper slide.

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The second-quarter growth figure was been slower than the Bank of Canada predicted it would be only weeks ago. As recently as April, the central bank's forecast for second-quarter growth was 3.8 per cent. In late July, policy makers cut that estimate -- but only to 3 per cent.

Now that the results are in, speculation is intensifying that Governor Mark Carney, who has raised rates twice this year while his Group of Seven colleagues remained on the sidelines, may keep the benchmark interest rate at 0.75 per cent at his Sept. 8 decision.

Avery Shenfeld, chief economist at CIBC World Markets in Toronto, said Mr. Carney faces a ``very close decision,'' but should probably pause and spend a few more weeks monitoring developing stories such as the teetering U.S. rebound.

``We're already seeing the economy slowing in the second quarter, a time when U.S. imports were still quite strong and, looking ahead, we can expect both less import demand from the U.S. and the fading of economic stimulus in Canada in 2011,'' Mr. Shenfeld said in an interview. ``This isn't a case of the economy falling off the cliff, but we will likely need unusually low interest rates for a while in order to continue to get growth in the range we're seeing.''

Trade held the economy back for a second straight quarter, as softening global demand meant a 1.5-per-cent gain in overseas sales that was dwarfed by a 3.9-per-cent increase in imports.

Investment in housing, a linchpin of Canada's initial rebound as record-low mortgage rates and government incentives spurred a rush of home buying and renovation projects, increased 0.3 per cent - the slowest in five quarters.

Still, there were bright spots. Companies' investment on plants and equipment increased 3.5 per cent - the biggest quarterly gain since 2005 as spending on machinery and equipment rose, an encouraging sign that the private sector is moving in to fill the void that will be left next year when stimulus measures run out. The pickup in business investment helped Canada's final domestic demand, minus trade, increase 0.9 per cent during the quarter.

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Chuck Phillips, chief executive officer of Armtec Infrastructure Income Fund, a Guelph, Ont., maker of pipe, noise barriers and construction products, said business investment should bounce back even more in the coming months, even if the economy expands at a gentle pace.

"There is quite a bit of cash on corporate balance sheets," Mr. Phillips said, "and once people get comfortable with the notion that there is only a small risk of a double-dip,'' that will translate into stronger investment.

Other business executives also seem sanguine about Tuesday's report.

Donald Lang, executive chairman of Toronto-based specialty packaging company CCL Industries Inc., which has operations around the world, said while he expects growth to be ``flat-lined for the foreseeable future,'' that's not a bad thing "because the good operations will succeed."

Mr. Lang contrasted the current climate with the artificial euphoria of rapid expansions such as the boom years in the middle of the decade, when "high water raised all ships, including some bad operations."

Indeed, some argue the economic environment is strong enough to warrant further rate hikes, even though inflation has been more tame than policy makers expected and a number of other Canadian indicators point to a slower third quarter as well.

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Christopher Ragan, a McGill University professor who is leading the C.D. Howe Institute's research on monetary policy, said Canada's recovery is ``on a less uncertain track'' than the rest of the world, so the central bank needs to continue moving borrowing costs closer to what most analysts consider ``neutral,'' which is to say about 4 per cent.

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About the Authors
Economics/business writer

Jeremy has covered Canadian and international economics at The Globe and Mail since late 2009. More

Reporter, Report on Business

Richard Blackwell has reported on Canadian business for more than three decades. At the Financial Post and the Globe and Mail he has covered technology, transportation, investing, banking, securities and media, among many other subjects. Currently, his focus is on green technology and the economy. More

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