Declining exports are chiefly to blame, as spending power in the United States – Canada’s chief trading partner – has significantly contracted since the onset of the credit crunch and subprime mortgage crisis last summer.

Exports – and in turn, the Canadian economy – started losing momentum in the second half of 2007. Cutbacks in manufacturing hurt exports, most notably motor vehicles, Statistics Canada reported today (Friday).

The slowing economy gives the Bank of Canada more reason to further cut overnight interest rates again at its next meeting June 10. Last month, Bank Governor Mark Carney cut rates by half a point to 3.0% for the second consecutive month.

“Some further monetary stimulus will likely be required to achieve the inflation target over the medium term. Given the cumulative reduction in the target for the overnight rate of 150 basis points since December, the timing of any further monetary stimulus will depend on the evolution of the global economy and domestic demand, and their impact on inflation in Canada,” the Bank said in an April 22 statement announcing its last rate cut.

The Bank projects the Canadian economy to grow by 1.4% in 2008, 2.4% in 2009 and 3.3% in 2010.

Why Canada Shouldn’t Be Too Worried

All this is kind of tragic for Canada, where its domestic demand remains strong because of rising incomes and commodity prices. Yet, all this is more or less offset by weakening exports.

But there’s a happy ending.

In today’s world, where interest rates are low and commodity prices are high, Canada’s in a very strong position for two reasons:

• It has oil reserves – somewhat larger than the Middle East – in the form of the Athabasca tar sands.
• And it’s the world’s largest producer of uranium, with 25% of the world market. For purposes of comparison, Australia is second, with about 23%.

Canada’s wealth of resources protects the country from the rampant inflation spreading around the world. Its core and total consumer price index (CPI) inflation are projected to be slightly below 2% in 2009 and 2% in 2010.

However, as strong as domestic demand is, the health of the U.S. economy is the ultimate indicator of Canada’s economic health.

“The economy here has not only ground to a halt, but is contracting. It’s weaker than the U.S. economy, which I think is probably a surprise to a lot of people,” Ted Carmichael, chief economist at JPMorgan (JPM) Canada, told Reuters.

Source: Canada’s Negative GDP in the 1Q Doesn’t Spell Disaster