The Bank of Canada has trimmed its growth forecast for the economy this year. In its update to the October Monetary Policy Report, which was released today, the central bank said it expects growth of 2.75% for 2004, down from the 3.25% it predicted in October.

For 2005, growth is forecast to rebound to 3.75%.

In the update, the bank said that inflation is expected to expected to remain benign this year.

Core inflation is projected to fall below 1.5% in early 2004, before gradually moving back to the 2% target by the end of 2005

“If oil prices ease to about $30 US per barrel in the second half of 2004 and $28 US in 2005, as suggested by futures contracts, total (consumer price index) inflation should remain below core inflation through 2005,” the bank said.

The Bank of Canada said three developments were responsible for the drop in its economic forecast: stronger-than-expected world economic growth; the continued drop in the U.S. dollar; and a larger output gap in Canada at the end of 2003.

The central bank said the main threats to its current outlook depend on the Canadian economy’s reaction to higher commodity prices and the continued rise in the dollar.

Faced with that weaker-than-expected growth, earlier this week the bank cut its key interest rate by 25 basis points to 2.5%.

Bank of Montreal says that the revised forecast from the central bank suggests that interest rates may need to go still lower to boost the economy.

BMO says that it now expects the Bank of Canada to reduce overnight rates by 25 basis points at the March 2 fixed announcement date. However, it expects the cuts to stop there, as stronger results start to reveal themselves. And, it predicts, “the Bank will gradually unwind the rate stimulus beginning in December.”

TD Bank echoes BMO’s view, saying, “The one overriding conclusion that can be drawn is that another rate cut is in store, to offset the drag from the Canadian dollar’s flight.” It says that a March cut is now a given.

RBC Financial agrees that it appears as though the Bank retains an accommodative stance on near-term monetary policy directions. But it doesn’t make any hard calls on future rate moves. “The Bank communicated to markets that it is optimistic about the longer term outlook but that near-term risks point to the possibility of a further easing in monetary policy in order to support faltering aggregate demand,” it concludes.

Even before the update, CIBC World Markets was suggesting that rates would come down aggressively this year to fight the currency effects. It said in a report, “It will take another 75 basis points of interest cuts from the Bank of Canada to meaningfully reduce the loonie’s enormous yield advantage over the U.S.. Without that interest rate support, the loonie will offer very limited appeal to global investors who wish to diversify out of U.S. dollars… If the Bank of Canada pilots its interest rate setting to a more normal gap against the federal funds rate, the Canadian dollar is likely to trade in the low 70¢ range by the end of this year or by early 2005.”