Canada's trade surplus fell in September to its lowest level since December 1998 as exports decreased and imports rose in the month the loonie returned to parity with the U.S. greenback.

Exports fell 2.3 per cent to $37.7 billion in September, the lowest level since October 2006, while imports rose 2.2 per cent to $35.1 billion.

The country's trade balance with the world narrowed to $2.6 billion from August's surplus of $4.3 billion, Statistics Canada said Friday.

That surplus was much smaller than the $3.9 billion the market had expected. The loonie weakened by a third of a cent to $1.0650 US in late-morning trading. 

The trade surplus with the United States — Canada's top trading partner — shrank to $6.2 billion from $6.9 billion the month before. Canada's trade deficit with countries other than the United States grew to $3.5 billion as the loonie appreciated against most other currencies.

Between January and September 2007, based on the Bank of Canada's monthly noon spot rate average, the Canadian dollar appreciated 13 per cent against the greenback.

The loonie reached parity with the U.S. dollar on Sept. 20. When it briefly pushed past $1.10 US in early November, analysts said future trade reports could show a worsening picture for Canadian exporters as their products become more expensive for U.S. buyers.

Rate cut coming, analysts say

"With the currency likely to remain elevated into early 2008, the trade sector is likely to act as a bigger drag on the pace of growth than the Bank of Canada assumed in its October forecast," said Dawn Desjardins, senior economist at RBC Financial Group. 

She predicts the central bank will "nudge down" interest rates in the first quarter of 2008 to counteract the drag.

Other economists agreed that a rate cut is in the cards in the next few months as Canada's trade balance weakens and GDP growth comes under pressure.

"September could mark the beginning of a deep slide in Canada’s trade balance, which will weigh on growth in coming quarters, spur the Bank of Canada to trim rates in the spring, and ultimately take the fire out of the loonie’s belly," said BMO Capital Markets' Sal Guatieri.

Statistics Canada said sharp declines were seen in September exports of machinery and equipment, and industrial goods and materials, the two most important sectors in terms of value. Those declines overshadowed gains in automotive products, energy products and other consumer goods.

Canadians imported more energy products, industrial goods and materials, automotive products and other consumer goods in September.