The Canadian economy grew by 1.1% in the third quarter over the second quarter, sharply lower than consensus expectations for a gain of 2.1%. However, economists don’t see the result as weak enough to bring on a rate cut next week.

Statistics Canada said that consumer spending and business fixed capital investment were the main sources of strength, boosting final domestic demand to a robust 1.4% gain. The main sources of weakness came from exports and business non-farm inventories.

The most shocking part of the report was the comparison of Canada’s economy with that of the U.S. On an annualized basis, real GDP grew 1.1% in Canada in the third quarter versus a gain of 8.2% in the U.S. That marks a shift in economic fortune for Canada compared with the U.S., which economists are blaming on the effect of a stronger Canadian dollar on our exports.

Despite the lag from the U.S. economy, RBC Financial says that there are a number of encouraging nuggets to be found in this report. “The first is that the quarter ended on a very strong note with a 1.1% gain in the month of September alone, in no small part due to a strong manufacturing recovery at the quarter’s end and the resumption of normal levels of activity in the public sector after the effects of the August power blackout.” It also notes that final domestic demand remains very strong.

“With growth being revised downward over previous quarters to only 2.0% in the first quarter and -0.7% in the second quarter, the third quarter expansion of 1.1% likely points to the Canadian economy being challenged to even come close to cracking the 2% mark for the year as a whole with the focus now shifting towards the fourth quarter numbers,” RBC says. “However, with the quarter ending on a strong note in September, the effects of one-off shocks ranging from SARS to BSE to the August black-outs lifting, a U.S. recovery in full-tilt, and businesses finally addressing their inventory challenges, the stage should be set for a much stronger fourth quarter and continued acceleration into 2004. This should also mean that the Bank of Canada is unlikely to make any changes in its next interest rate announcement on Tuesday.”

BMO Nesbitt Burns agrees that the headline number is a disappointment, and says that it adds some spice to next week’s Bank of Canada interest rate decision. “It’s a closer call, but this is probably not enough to prompt the Bank to make a move next week,” it says.

CIBC World Markets insists that this report wasn’t nearly as bad as the headline figure would suggest. “If anything, the underlying strength of domestic demand was more robust than envisioned. Faced with a growth resurgence in the final quarter of the year, the Bank of Canada likely won’t find itself in any type of hurry to cut rates,” it says. “But as damage from the loonie’s run-up becomes more apparent and the base of comparison for growth no longer is so easy to beat, look for the Bank to counteract currency headwinds with further easing a few months into next year.”