FILE PHOTO: The Canadian Pacific railyard is pictured in Port Coquitlam, British Columbia February 15, 2015. REUTERS/Ben Nelms/File Photo

By David Ljunggren

OTTAWA (Reuters) - Canada's economy grew by a stronger-than-expected 0.2 percent in July, boosting market expectations that the Bank of Canada would raise interest rates next month for the fifth time in little over a year.

Analysts in a Reuters poll had forecast 0.1 percent growth from June. Statistics Canada said on Friday that 12 of the 20 sectors gained.

The figures are significant because the Bank of Canada earlier this month forecast that temporary factors would weigh on third-quarter gross domestic product. Governor Stephen Poloz on Thursday pledged to raise rates gradually and closely watch economic data.

The next fixed interest rate decision is on Oct 24. The bank has hiked rates four times since July 2017 as the economy strengthened and unemployment neared record lows.

Graphic - Canada monthly GDP, exports to the U.S.: http://link.reuters.com/jev87s

Graphic - Canada economic snapshot: http://tmsnrt.rs/2e8hNWV

Graphic - Canada producer prices : http://link.reuters.com/cuj92t

Stephen Brown, senior Canada economist at Capital Economics, said the economy was on track for third-quarter annualized growth of about 2 percent.

"That would be stronger than the 1.5 percent expected by the Bank of Canada and is therefore another reason to expect the Bank to raise interest rates next month," he said in a note.

Market expectations of an interest rate hike in October were reflected in overnight index swaps, which rose slightly to 78.27 percent from 76.46 percent.

The Canadian dollar added to earlier gains after the report, touching C$1.2978 to the U.S. dollar, or 77.05 U.S. cents.

"A Bank of Canada hike in October already looked like a near-lock, but today's report will fuel more speculation around a follow-up in January," said Andrew Kelvin and Mark McCormick at TD Securities.

Statscan said the manufacturing sector increased by 1.2 percent as key segments recovered after shutdowns for maintenance and retooling. Output of petroleum and coal products climbed by 7.6 percent.

Wholesale trade grew by 1.4 percent after a 1.2 percent decline in June. The utilities sector expanded by 2.1 percent as a heat wave boosted demand for electric power generation and distribution.

Avery Shenfeld, chief economist at CIBC Capital Markets, took a more cautious tone, saying an October rate hike would depend on the fate of slow-moving talks to renew the North American Free Trade Agreement.

Poloz though indicated on Thursday that even if trade ties with the United States deteriorated, higher rates might be needed to counter the effect of tariffs.

Separately, Statscan said producer prices fell 0.5 percent in August, pulled down for the second consecutive month by lower prices for primary non-ferrous metal products.





(Additional reporting by Fergal Smith in Toronto; Editing by Jeffrey Benkoe)