With the economic recovery flagging, the Bank of Canada (BoC) could roll out a surprise rate cut again next month, suggest economists at Desjardins Group.

The report says that the first half of 2015 “has been even more challenging than previously thought.” For instance, it notes that real gross domestic product (GDP) contracted at an annualized quarterly rate of 0.6% in the first quarter and that growth is expected to be “quite limited” for the second quarter.

“This prognosis is much bleaker than the Bank of Canada’s latest projections, which called for zero change in real GDP in the first quarter and a gain of 1.8% in the second quarter,” states the report.

As a result, the firm expects the BoC to revise its forecasts down in its next Monetary Policy Report on July 15 and says that these disappointing results in the first half of 2015 “will have repercussions on the excess production capacity of the Canadian economy as a whole.”

Desjardins estimates it will take approximately two years to win back the ground that was lost in the first half of 2015. This should push back the prospect of BoC interest rate hikes, it says. The firm now expects that the central bank will put off raising rates until the fourth quarter of 2016.

“In the meantime, while the continuation of the status quo is the most probable scenario, we cannot entirely rule out the possibility of the monetary authorities ordering new interest rate cuts, should the expected recovery of the Canadian economy fail to materialize,” the report states. “It could even cause another surprise by lowering its key interest rates at its July meeting.”

In this environment, Desjardins says Canadian bonds are likely to outperform U.S. bonds, especially in the short end of the curve.

On the other hand, Desjardins sees a different fate for the U.S. where economic statistics “have become far more encouraging in recent weeks,” with both housing and employment data holding up as well as auto and retail sales rallying in May. Against that backdrop, it is expecting the U.S. Federal Reserve will start raising its key interest rates in September.

“After that, the pace of rate hikes will probably be slow and irregular,” the report notes. “The top of the federal fund target range should stand at 0.75% by the end of the year and at 1.50% by the end of 2016.”