The Canadian economy shrank at an annualized rate of 0.3 per cent over the first three months of the year, the first such contraction since the second quarter of 2003, Statistics Canada said Friday.

Cutbacks in manufacturing got much of the blame, as a big drawdown in motor-vehicle inventories led to lower auto manufacturing and exports. Bad weather also contributed to the weak first-quarter reading.

Statistics Canada said the economy started to lose momentum in the second half of 2007 as exports declined.

Economists had been expecting first-quarter annualized growth of 0.4 per cent. The Canadian dollar traded lower as traders speculated that the Bank of Canada may be more aggressive in cutting interest rates. The loonie fell by four-tenths a cent to close at 100.70 cents US.

'Much weaker than expected'

"This report was much weaker than expected by both the street and the Bank of Canada, which forecasted a one per cent annual rate increase in output," said RBC assistant chief economist Dawn Desjardins.

Desjardins added that the result supports the market’s expectation that the Bank of Canada will cut its key interest rate by a quarter of a percentage point on June 10.

Other economists speculated that more rate cuts could follow later in the year.

"The weak economic performance builds the case that further rate cuts beyond [June 10] are a good possibility," TD Bank economist Pascal Gauthier said.

For March, economic activity slowed by 0.2 per cent, Statistics Canada said, providing a weak handoff to the second quarter.

"The lack of momentum points to risks that the second quarter won't be a whole lot better," warned CIBC World Markets economist Avery Shenfeld.

Flaherty says economy will avoid a recession

"I want to reassure all Canadians that we are well positioned to weather this period of global economic uncertainty," Finance Minister Jim Flaherty said Friday after meeting with provincial finance ministers in Montreal.

Flaherty said he doesn't believe the economy will slip into a recession. "If some people are saying [Canada is entering a recession], I disagree with them," he said.

"Yes, there's slowness in the auto sector … forestry sector. But the strength of the economy across the country is quite remarkable."

The slumping auto manufacturing industry was a key factor in the first quarter's outcome.

Production downtime for retooling, coupled with a strike at a major U.S. supplier and dealer incentives to cut inventories, contributed to a 2.5 per cent drop in output for Canada's overall manufacturing sector.

Statistics Canada said the slower auto sector was responsible for 40 per cent of that drop.

Excluding the auto manufacturing sector and its estimated ripple effects on other sectors such as motor vehicle parts, wholesaling and transportation, GDP for the remainder of the economy grew by 0.1 per cent in the January-March quarter, Statistics Canada said.

Canadian exports of goods and services fell for the third consecutive quarter, dropping by 1.1 per cent, with the automotive sector again responsible for the tumble.

Consumer spending kept growing in the first quarter, but at a slower pace than the last quarter of 2007.

Personal spending grew 0.8 per cent in the first quarter, down from the 1.8 per cent gain in the last three months of 2007. The deceleration was mainly due to lower spending on travel abroad.