(Recasts lead, adds market reaction, details)
By Gilbert Le Gras
OTTAWA, July 13 (Reuters) - Canada's trade surplus plunged by a quarter to C$5.22 billion ($3.92 billion) in May as imports hit a record, with the country bringing in the highest level of machinery and equipment in 20 years, Statistics Canada said on Tuesday.
Analysts had forecast a trade surplus of C$7.40 billion.
Statscan also revised April's surplus down to C$7.03 billion from a preliminary C$7.58 billion.
"This implies that domestic demand is becoming more evenly balanced between consumer spending and business investment," Merrill Lynch economist Robert Spector said.
"This is a clear signal that business investment has suddenly bolted higher, confirming the upturn flagged in yesterday's Bank of Canada Business Outlook Survey," said BMO Nesbitt Burns' chief economist Sherry Cooper.
Excluding the United States, Canada ran a trade deficit of C$3.06 billion with all other countries. Imports increased from most major trading regions, particularly Japan and the newly expanded European Union, Statscan added.
Imports set a record high of C$31.57 billion, up 7.8 percent from April and marking the biggest monthly gain since January 1997, Statscan said.
"Despite the significant gain in imports, Canada's cumulative trade surplus for January to May is nearly C$4.5 billion higher than it was in the same five-month period last year," Statscan added.
Exports rose for the fourth straight month to C$36.79 billion, up 1.3 percent from April. Canada's second and third largest export sectors -- industrial goods and machinery and equipment -- were the only sectors in decline, Statscan said.
The Canadian dollar fell to C$1.3285 against the U.S. dollar, or 75.27 U.S. cents, after the data were issued, from C$1.3200, or 75.75 U.S. cents, just ahead of the report. U.S. trade numbers, also released on Tuesday, were also a factor the the Canadian currency's fall, with the U.S. trade deficit declining.
The Canadian numbers were also being factored into speculation on when the Bank of Canada will next raise interest rates as the economy starts to heat up.
"At the margin, the rise in domestic demand may be yet another factor tilting the odds to a September (interest) rate hike, (and) we remain of the view that the rate cycle would be more gentle than in the past," Spector said.
The Bank of Canada sets interest rates next week and then on Sept. 8 after cutting rates three times earlier this year to 2 percent to stimulate domestic demand in the wake of a slew of economic shocks last year.
($1=$1.33 Canadian)
(Additional reporting by Ka Yan Ng in Toronto)