In its latest Monetary Policy Report, the Bank of Canada says that inflation has fallen “faster and further” than expected just a few months ago while economic growth has been weaker than expected.

The bank said growth has been more sluggish than previously predicted, although it still expects the economy will expand by about 2% this year.

Back in April, the bank predicted 2.5% growth in the first three quarters of 2003; that’s now been downgraded to an average of 1.5% for the same period.

Core inflation, which the bank follows closely, will drop to as low as 1% early in 2004, down from 2% predicted in April, the bank said.

It predicts that core inflation should return to 2% by mid-2005, as economic slack is taken up. “Total CPI inflation will continue to be importantly affected by swings in the price of crude oil,” it says. “If prices ease to US$27 per barrel next year, total CPI inflation would likely fall below core inflation in 2004.”

The core rate last month was 1.7% below the bank’s preferred rate of 2% and much lower than the 3.1% in February.

The bank sees the economy gaining strength in the fourth quarter and through 2004. “On balance, the expansion should be above the rate of potential growth, relying primarily on solid household spending and increased business investment. Stronger growth abroad should boost foreign demand for Canadian products, but this will be dampened by the higher value of the Canadian dollar,” it says. “With growth above potential, the slack in the economy should be absorbed by early 2005.”

However, the Bank allows that there are significant downside risks to its outlook. “These risks relate to the timing and magnitude of global demand, price, and exchange rate adjustments to economic imbalances. In particular, there is uncertainty both about the likely changes in key global exchange rates and their effect on the Canadian economy. There is also uncertainty about the sustainability of U.S. growth beyond mid-2004,” it cautioned.