The Bank of Canada today announced that it is lowering its target for the overnight rate by one-quarter of one percentage point to 4.25%.

The operating band for the overnight rate is correspondingly lowered, and the bank rate is now 4.5%
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Ahead of the the central bank’s decision, the Canadian dollar opened at US99.55¢, down more than two-fifths of a cent from Monday’s close.

On Monday, the loonie closed below parity for the first time since September 27, hitting US99.98¢.

In its accompanying statement, the bank said “that the downside risks to the bank’s inflation projection have increased” since the release of its Monetary Policy Report in October.

“Global financial market difficulties related to the valuation of structured products and anticipated losses on U.S. sub-prime mortgages have worsened since mid-October, and are expected to persist for a longer period of time.”

“There is an increased risk to the prospects for demand for Canadian exports as the outlook for the U.S. economy, and in particular the U.S. housing sector, has weakened,” the bank stated.

As a result, “the bank judges that there has been a shift to the downside in the balance of risks around its October projection for inflation through 2009.”

Bay Street economists had been divided over whether the central bank would cut the overnight rate.

But they are calling for rates to go lower still, despite a lack of clues from the Bank as to its next move.

National Bank Financial says that the central bank was justified to proceed with a pre-emptive rate cut this morning. “Arguably, domestic demand remains strong in our country, but this strength must now be weighted against a significant deterioration in global credit markets, a strong currency, and the risk of a sharp economic slowdown in the United States. With inflation better behaved, the backdrop was favourable for the Bank take an insurance policy against downside risks to the economic outlook,” it says.

However, it notes that the Bank did not venture to provide guidance on its future course of action. “Given the unusual volatility in global financial markets and the upcoming employment report, the Bank preferred to leave all of its options open,” NBF notes.

RBC Financial says that today’s press release indicates that policymakers are increasingly nervous about the impact of the global financial market turmoil on the outlook for growth and inflation and sets up for additional easing should these conditions persist in 2008.

“Our view that Canada’s economy, like its US counterpart, is headed for a period of slower growth means that it is likely that the Bank will cut the policy rate again early next year,” RBC explains. “Like the Bank, we expect that the aggressive price cutting by Canadian retailers will keep downward pressure on Canada’s core inflation rate allowing the Bank to pursue an easier policy stance as the economy navigates through this period of financial market turmoil.” It says that the downside risks emanating from the financial market uncertainty, commensurate tightening in credit conditions and weakening US growth outlook seals the case for an additional rate cut in early 2008.

BMO Capital Markets agrees that the Bank is likely to trim rates again in January. “The Bank is still officially concerned about upside risks to inflation (given a very low jobless rate), but the credit squeeze and a possible U.S. recession are the dominant concerns now. As well, with core inflation now below 2% and potentially headed lower thanks to a wave of retail price cuts in Canada, this gives the Bank ample room to respond to any deepening market turmoil with further rare relief,” it says. “Still, we expect the Fed to be much more aggressive than the Bank of Canada on the rate-cutting front in the months ahead.”

That view is echoed by TD Economics, which says that the downside risks to the U.S. economy will likely push U.S. policy makers to deliver the first of three additional quarter point rate cuts at its meeting on December 11th.

NBF sees an additional 50 bps of easing in Canada, putting the overnight rate at 3.75% by the second quarter of 2008. “We doubt the Bank of Canada will need to ease more than 50 basis points over the next six months. If the downturn of U.S. growth that we anticipate were to degenerate into an outright contraction, or if the ongoing global liquidity squeeze were to worsen, our central bank would obviously take more forceful action,” it concludes.

@page_break@The Bank of Canada’s next scheduled date for announcing the overnight rate target is Jan. 22, 2008.