The Canadian economy shrank at an annualized rate of 3.4 per cent in the fourth quarter, Statistics Canada said Monday.

Economists had been projecting an annualized contraction of 3.6 per cent.

The economy showed signs of tailing off sharply at the end of 2008 as real gross domestic product dropped one per cent in December. Almost all major sectors reduced production.

The December drop followed a 0.7 per cent decline in November.

Following the report, the Canadian dollar dropped on global currency markets. The loonie closed at 77.44 cents US, down 1.16 cents from Friday's close.

The weak economic report comes one day before the Bank of Canada makes its next decision on interest rates. The central bank is widely expected to cut a key rate again.

"The steady decline in monthly growth through the fourth quarter suggests little indication that the pace of decline is poised to reverse going into 2009," said RBC assistant chief economis Paul Ferley. "As a result, we expect that the Bank of Canada will opt to cut the overnight rate another 50 basis points to 0.50 per cent following tomorrow’s policy-setting meeting."

Paul Ferley, Assistant Chief Economist, RBC Economics Research

Decline more severe in U.S., Europe, Japan

Statistics Canada said the fourth-quarter drop in Canada's gross domestic product came at the fastest pace since 1991.

Canada's 3.4 per cent annualized drop compared with a 6.2 per cent decline in the US economy, a decline of 5.9 per cent in the quarter for the European Union, and a decline of 12.7 per cent in Japan.

"Canada was the cleanest horse in a muddy race," said BMO Capital Markets economist Douglas Porter.

The Canadian economy contracted as exports, consumer spending and capital spending all fell during the quarter.

Exports of Canadian goods and services dropped 4.7 per cent in the October-December quarter, marking a sixth consecutive quarterly decline. Statistics Canada said that was a first since quarterly estimates began over 60 years ago.

Personal spending fell for the first time since the fourth quarter of 1995, dropping by 0.8 per cent as declines for both goods and services contributed to the decline.

Business investment in machinery and equipment contracted 7.5 per cent in the last quarter of 2008. All categories recorded declines, most notably automobiles, trucks, and industrial machinery.

Based on the poor fourth-quarter reading, Porter said the economic situation looks even worse for the current quarter.

GDP is expected contract at roughly a six per cent annualized rate in Q1, challenging the 5.9 per cent annualized drop seen in the first three months of 1991 for the weakest quarterly performance in data dating back to 1961, he said.