OREANDA-NEWS. The fifth consecutive monthly fall in Canadian GDP highlights some long-standing challenges to higher growth and economic rebalancing, Fitch Ratings says.

Statistics Canada said last week that real GDP declined by 0.2% in May, with the output of goods-producing industries falling 0.6% due to contraction in manufacturing and mining, quarrying, and oil and gas extraction. A technical recession is now likely after GDP contracted in 1Q15, at an annualized rate of 0.6%, largely due to the negative impact of lower global energy prices on business investment and stuttering first-quarter US growth.

Fitch does not expect the recession to deepen or broaden. A still-firm labour market and a US recovery starting in Q215 (exports to the US jumped 7.1% in June from May) hold out the prospect of a return to growth in 2H15, and we still expect the economy to expand over this year as a whole. Nevertheless, weak outturns year-to-date illustrate how high commodity dependence, narrow diversification of trade partners, and the slow shift from consumption and construction to capital investment and exports as growth drivers carry risks to growth.

Rising exports to the US were part of an overall 6.3% increase in exports in June - the first monthly rise of the year, according to Statistics Canada. This supports our expectation that the contribution of exports to growth will increase, but this has been smaller-than-expected so far in 2015. This is despite the sharp fall in the Canadian versus the US dollar and points to lagging competitiveness and possibly capacity issues.

Domestic non-oil growth has provided some compensation for energy and extractive-sector weaknesses. For example, construction grew 1.0% in May, according to Statistics Canada, as engineering and repair construction as well as residential and non-residential building construction all expanded. Retail trade also grew.

High household leverage presents a significant potential shock to the Canadian economy, although stresses such as higher rates or rising unemployment have yet to materialise. The Bank of Canada has responded to the downturn by cutting interest rates twice this year. We think house prices are 20% overvalued in real terms nationally (the regional picture is mixed, with some markets showing signs of weakness and others performing strongly). Mortgage rates have not responded significantly to the Bank of Canada's easing. We think the authorities will remain proactive in addressing macro-prudential risks, making a soft-landing in the housing market possible.

Economic weakness in 2015 has had a minor fiscal impact at the federal level. In its April budget the federal government reaffirmed its commitment to balancing the budget, although it cut its surplus forecasts to reflect lower-than-anticipated growth and revenues. These are more sensitive to overall nominal GDP than to oil prices. Whether the federal government returns to surplus in 2015/2016 or the following year, Fitch believes the improving trend is intact.

Fiscal credibility and sound macroeconomic policies have supported Canada's 'AAA'/Stable sovereign rating, which we are due to review later in August.