With all the drama surrounding the U.S. debt ceiling debate, Statistics Canada's latest report on the Canadian economy largely went ignored.

And it wasn't pretty, with the country's gross domestic product falling by 0.3 per cent in May after a flat performance in April and only a 0.3 per cent increase in March.

Emanuella Enenajor, an economist at CIBC World Markets was blunt, calling the GDP report "disturbing."

In fact, by almost any measure it seems as if the gloom surrounding the U.S. and its sputtering economy is spreading north, and bringing with it the clear possibility that Canada may be heading into a rare double-dip recession.

"If the U.S. goes into recession we will certainly have one here, although it might not be as deep," says Mike McCracken, chief economist at Ottawa-based Infometrica. "We could beef up our economy with a stimulus program to help prevent it, but we won't because we have a government that makes the Tea Party look like Liberals. So we could go into recession as well."

Bank of Canada Governor Mark Carney seemed to acknowledge the depth of the slowdown when the central bank cut its second-quarter growth forecast to 1.5 per cent from two per cent. He also revised its growth outlook for 2011 to 2.8 per cent, down from the previous estimate of 2.9 per cent.

The economic news out of Europe is particularly grim.

In fact, concern over the economy and the debt crisis may force the European Central Bank to postpone a third interest rate increase that had been expected to kick in later this year.

It doesn't appear as if the ECB or IMF had much choice. In July they agreed to loan €109 billion to Greece to help it make payments on its foreign debt, but doubts remain about the long-term solvency of Italy and Spain.

And these two countries would be too large for the Eurozone's €440 billion rescue fund to save from collapse if their economies worsened and the bond markets refused to lend them more money.

Complicating the issue on both sides of the border is the looming decision to cut government budgets and eliminate jobs at a time when the economy is clearly slowing.

But McCracken believes the Harper government will continue its drive to erase the federal deficit in three years.

"It's a strategy that's as dumb as the debt limit in the U.S.," says McCracken. "It's going to slow down consumption and investment in Canada and lower GDP. There is no payoff with better economic performance."

And that puts Carney and U.S. Federal Reserve Chairman Ben Bernanke in a difficult position.

When testifying before Congress in July, Bernanke said the Fed may have to take new measures to stimulate the economy if it stalls again, something it appears to be in the process of doing if it hasn't already.

To help hold off a second recession, the Fed could begin a new round of bond purchases, and keep interest rates at record lows for a longer period.

"Growth in the first half of the year in the U.S. was dangerously close to zero," said Roberto Perli, director of policy research at International Strategy & Investment Group.

"At a minimum, the Fed will have a serious debate about the policy options - what they should do, and what they expect to get from it."

Carney has yet to show his hand, but has stated in the past that troubles abroad have kept the Bank of Canada from raising rates in recent months. But with the Bank of Canada rate already at a bedrock low of one per cent, it does not leave him with much room to stimulate the economy by lowering rates.

"We could possibly see a cut in interest rates," says McCracken. "But we would need to see some real weakness."

And speaking in Toronto this week, Federal Finance Minister Jim Flaherty seemed to be talking about a further economic slowdown when he warned that "Canada is not an island" and will be affected by the growing economic troubles in Europe and America.

With U.S. law makers threatening to make deep cuts over the next year, even with the U.S. economy now at standstill, Flaherty warned against "sudden, or dramatic, or draconian moves" to slash government spending in the U.S.

The slowing world economy may also soon have to deal with a possible downgrade of U.S. debt.
Even though the agreement on the debt ceiling will initially cut $900 billion in expenditures and then another $1.5 trillion to either be voted on later or imposed as across-the-board cuts, it may not appease the rating agencies, which have placed the U.S. on their "watch" list and may yet cut the country's coveted AAA rating to AA later this year.

"What the credit agencies want to see is a stabilized or flat debt-to-GDP ratio," explained Morningstar Investment Management economist Francisco Torralba, "and that is not what you get with this deal."

According to a JPMorgan Chase & Co. research report, if the U.S. credit rating is cut it would likely raise the nation's borrowing costs by increasing the yield on treasuries by almost one per cent, which would cost borrowers in the U.S. almost $100 billion a year. And when those increases wash through an already stagnant economy, it can only result in more job losses.

A downgrade in the U.S. would almost certainly send the Canadian dollar, now floating around $1.05US even higher, as investors rush to the safe haven of the Canadian dollar. The affect on the Canadian manufacturing sector would be immediate with the high-cost dollar pricing more Canadian exports out of the U.S. market.

If there is a silver lining that may help Canadian consumers and the manufacturing sector, McCracken says a global slowdown, commodity prices - especially oil - could fall on lower worldwide demand.

As a result that could cause inflation to fall over the coming months, and take the pressure off Carney to raise rates, and even allow some Central Bankers to cut rates if the economy slows dramatically.

"We could beef up our economy with a stimulus program to help prevent it, but we won't because we have a government that makes the Tea Party look like Liberals.