Canadian factory sales rose twice as much as expected in July, making a recession look less likely as the economy shows signs of picking up in the third quarter after an unexpected slump in the second.

Sales jumped 2.7 percent in the month to C$46.7 billion ($46.7 billion) following three straight months of declines and beating estimates of a 1.3 percent gain, Statistics Canada said on Thursday.

Sales in constant dollars, used to calculate gross domestic product, rose 2.8 percent and shipments outside the auto sector were also encouraging, up 2.3 percent.

The Canadian dollar barely reacted to the news and economists cautioned that the widening European debt crisis and weak U.S. economy will keep Canadian economic growth modest, echoing comments made by Finance Minister Jim Flaherty on Wednesday.

After the economy shrank 0.4 percent, annualized, in the second quarter due to supply disruptions resulting from the tsunami in Japan, most economists have expected a reversal of fortune in the third quarter although Scotiabank said this week that the country may be in another recession already.

While this diminishes the risk of a recession, we do not expect that the strength of this release to be maintained given some of the headwinds facing the global economy, said Mazen Issa, macro strategist at TD Securities.

The ongoing turmoil in Europe and weak growth backdrop in the U.S. remain the greatest risks, he said.

Analysts surveyed by Reuters forecast the Bank of Canada will hold interest rates at an ultra-low 1 percent at least until the third quarter of 2012, although markets are still pricing in a rate cut as the bank's next move.

Other data released on Thursday showed new motor vehicle sales fell 6.2 percent in July, partly offsetting gains in the previous month.  

In August, sales of existing homes remained stable for the second straight month while year-to-date sales were in line with the 10-year average, according to the Canadian Real Estate Association.

OIL BOOST

Canada's oil industry was the biggest contributor to the manufacturing gains as some refineries ramped up production after maintenance work, boosting sales in the petroleum and coal products industry by 6.1 percent in July.

Primary metals and fabricated metal products also noted hefty gains. All in all, 15 of 21 industries representing about 75 percent of total manufacturing capacity reported higher sales.

New orders in July rose 1.3 percent, driven by the metals, machinery and energy sectors. Unfilled orders in July rose to their highest level in more than two years and inventories edged 0.1 percent lower, the first decline since September 2010.

The ratio of inventory to sales fell to 1.35 from 1.39, the first drop since last January.