Investors are waking up to a surprise Tuesday. The Bank of Canada is lowering its target for the overnight rate by 25 basis points to 3%.

The operating band for the overnight rate is correspondingly lowered, and the Bank Rate is now 3.25%.

The bank says recent months have brought a number of unanticipated developments that bear on the outlook for inflation and economic activity in Canada. In the short term, says the bank, domestic economic activity has been undercut by the effects of SARS and the single case of mad cow disease in Alberta.

Meanwhile, foreign demand for Canadian products has also been weaker than anticipated. Finally, the sizable appreciation of the Canadian dollar against the U.S. dollar is likely to have “a dampening effect on the demand for tradable Canadian goods and services.”

Based on these reasons the bank decided to lower the rate. Many economists had predicted the bank to stand pat. But the bank says, “Today’s interest rate reduction will provide support for domestic demand growth, and consequently for levels of aggregate demand consistent with keeping inflation on a track to meet the 2% target over the medium term.”

The Bank still expects that growth in the Canadian economy will strengthen towards the end of 2003 and through 2004.

The Bank’s next scheduled date for announcing the overnight rate target is September 3.

Investors will hear the latest news from the world’s most powerful central banker, Alan Greenspan when he testifies before congress at 10:OO ET. this morning.

Meanwhile, the U.S. Commerce Department is reporting that retail sales increased in June as American consumers spent more money on building materials, furniture, clothing and sporting goods. Retail sales rose 0.5%, the biggest monthly increase since March.

May retail sales were reported as unchanged, revised down from a previous estimate of a 0.1% rise. Excluding auto and gasoline sales retail sales were up 0.7% during the month.

Wall Street futures are mildly positive in response. The Canadian market will have the interest rate drop to react to as well.

In earnings news, Merrill Lynch & Co. reported its profit shot up 61% in the second quarter, marking the second-best results in the company’s history.

The largest brokerage firm in the U.S. on Tuesday reported net income jumped to US$1.02 billion, or US$1.05 a share, from US$634 million, or US66¢ a share, a year earlier.

In Tokyo, the Nikkei average slipped 4.63 points to 9,751.00, after Monday’s gain of 1.25%. The Nikkei was up in the morning on buying of technology stocks, but receded with afternoon profit-taking amid caution before Greenspan’s testimony. In Hong Kong, the Hang Seng index rose 13.15 points to 10,135.55.

In London, the FTSE 100 index is off 15.4 points or 0.4% at 4,112.2 at midday. Germany’s DAX has edged up 0.2%, while the Paris CAC40 has slipped 0.4%.