The Canadian economy expanded less than expected in the first quarter, with weak inventory growth offsetting strong consumption gains, prompting traders to boost bets on the Bank of Canada cutting rates as early as next week.

Gross domestic product in the first quarter expanded at a 1.7 per cent annualized pace, Statistics Canada reported Friday in Ottawa. That’s slower than a Bloomberg survey median estimate of 2.2 per cent and the Bank of Canada’s forecast of 2.8 per cent.

The statistics agency also downwardly revised fourth-quarter growth to 0.1 per cent from one per cent. While March economic output was flat, matching economist expectations, the statistics agency’s preliminary data suggest output in April rose 0.3 per cent.

Traders in overnight markets put the odds of a rate cut at next week’s meeting at about three quarters, from two-thirds the day before. Bonds rallied and the yield on the Canadian government two-year note fell 11 basis points on the day.

This is the last key economic data release before the Bank of Canada’s rate decision next Wednesday. The majority of economists in a Bloomberg survey expect policymakers to cut their key policy rate by 25 basis points at that meeting, marking the start of an easing cycle after keeping the rate at five per cent since July last year.

Governor Tiff Macklem and his officials are closely watching the balance between supply and demand in the economy as a key indicator of underlying price pressures. Friday’s report may raise concerns among less dovish officials that the economy may not have cooled enough to maintain downward pressure on price gains.

Economists reacting to the release broadly argued that it supported a June rate cut, but uncertainty remained about how a cautious Bank of Canada would respond. Resilient household spending and momentum heading into the second quarter may prompt policymakers to wait for more data. 

“The market is coming on board with a cut on Wednesday, but the conviction is not there. It’s the same for me,” Charles St-Arnaud, chief economist at Alberta Central, said in an email.

“The data support a cut, but will the Bank of Canada have the courage to do it just yet or would they rather wait to be 200 per cent confident?”

The headline numbers likely overstate the weakness in Canada’s economy, but the data confirm the bank needs to cut rates next week, Royce Mendes, director of macro strategy at Desjardins Securities, wrote to investors.

The GDP miss “came from the volatile inventories category,” he pointed out. “As a result, final domestic demand, a better gauge of underlying momentum, still advanced a heady 2.9 per cent in the first quarter. That’s obviously better news than in previous quarters, but is being aided by the growing population.”

First-quarter output landing more than one percentage point below the central bank’s estimate points to an even wider output gap than previously thought, said Benjamin Reitzes, rates and macro strategist at Bank of Montreal.

“There’s nothing holding the Bank of Canada back from cutting rates next week. It’s never a sure thing with the Bank of Canada, but they should be cutting,” he said in an email.

James Orlando, senior economist with Toronto-Dominion Bank, stood by his expectation of a July rate cut. The central bank has made efforts to boost transparency and forward guidance, he wrote to investors.

“We expect the Bank of Canada will hold rates steady next week and use the meeting to tee up a rate cut in July. That said, expect fireworks as the Bank of Canada could go either way with this one.”

The GDP release “killed the economic reacceleration argument” in favor of holding rates next week, said Simon Harvey, head of FX analysis at Monex Canada, in a report to investors.

“Not only has first-quarter growth undershot the Bank of Canada’s forecasts of both actual and potential growth, but it has done so against a much weaker base as fourth-quarter GDP was significantly revised lower.”

Monthly GDP figures showed that momentum faded after a strong start to the year that was driven by the end of labor strikes and mild winter weather, pointed out Katherine Judge, economist with the Canadian Imperial Bank of Commerce. 

In the first quarter, household spending on services rose, primarily driven telecommunications, rent and air transport. Household spending on goods also edged up, with higher expenditures on new trucks, vans and sport utility vehicles.

Housing investment also increased, with Ontario, British Columbia and Quebec recording the largest volume increases in resales while prices in these provinces fell.

Business capital investment grew, led by spending on engineering, mainly within the oil and gas sector. But there were widespread slowdowns in business investment in inventories, with accumulations easing in most industries, led by retail motor vehicles.

Compensation of employees rose and household savings reached the highest rate since early 2022 as gains in disposable income outweighed increases in nominal consumption expenditure. Corporate income fell.

According to preliminary data, manufacturing, oil and gas extraction and wholesale trade led the increases in April. All three of these industries, however, contracted in March.

The report was published at the same time as the U.S. Federal Reserve’s preferred measure of underlying U.S. inflation, which moderated in April.