The Bank of Canada will eventually start cutting rates once again, but not this year, according to an analyst at TD Securities.

In a research note issued yesterday, Marc Lévesque, chief strategist, North America FX & fixed income research, suggests that the central bank won’t be easing rates any time soon.

“Although there have been some signs of economic weakness on this side of the border, it is important not to forget the starting point that the Bank of Canada is looking at. And, that starting point is an economy that until recently, was operating squarely above its capacity limits,” Lévesque said.

“The Bank of Canada’s own measure of the output gap is now pointing to full capacity, the unemployment rate is close to a generational low, wage pressures have gained ground, and core inflation is bang-on its 2% target. That backdrop is most definitely not one in which the Bank would be comfortable cutting interest rates.”

Lévesque said that one of two things (or both) need to happen before the Bank will even contemplate easing monetary policy. “First, the Bank must revise its growth forecast downward, and enough below potential growth for it to see a meaningful output gap opening up over a 12-18 month time horizon. Second, even if the Bank keeps its forward-looking views intact, economic growth must unexpectedly come in well below the Bank of Canada’s expectations as a result of unexpected shocks to the economy or other unforeseen developments,” he suggested.

“Over time, we believe that both of these conditions will be fulfilled,” Lévesque said. “On the first front, the Bank of Canada has among the most optimistic forecasts for U.S. economic growth, at 3.2% for 2007. As growth starts to gear down south of the border, the odds are that the Bank of Canada will scale back its own view as well. On the second front, the much slower-than-expected pace of second-quarter growth has already eaten away at the situation of excess demand that the Bank was expecting, and third-quarter growth is not poised to come in any stronger, at about 2.0%. As a result, the economy will end up with a small output gap by the end of the third quarter.”

“All of this will eventually lead the Bank to ease,” Lévesque concluded. “However, that is not a story for 2006. In fact, the Bank of Canada currently views the risks to their outlook as evenly balanced to the upside and the downside – not the stuff of near-term rate cuts.”