The Bank of Canada said Thursday in its April Monetary Policy Report that it expects Canada’s economy to grow by about 2.5% in 2005 and 3.25% in 2006, with growth coming primarily from strength in domestic demand.

“The global economy has been unfolding largely as expected, and the outlook for the Canadian economy is essentially unchanged from that in the January Monetary Policy Report Update,” Bank governor David Dodge said in a statement. “There is increasing evidence that the Canadian economy is adjusting to major global developments, including the realignment of currencies and higher commodity prices.”

The Bank adds that the economy is operating slightly below its production capacity and to expect that it will move back to full capacity in the second half of 2006. Core inflation is expected to return to 2% around the end of 2006. Based on the scenario implied by oil-price futures, total CPI inflation is projected to remain slightly above 2% this year and to move slightly below 2% in the second half of 2006, it says.

“In line with this outlook for growth and inflation, a reduction of monetary stimulus will be required over time,” Dodge said.

“This outlook is subject to both upside and downside risks and to uncertainties. The risks include the pace of expansion in Asia and the prices of oil and non-energy commodities. A further risk relates to the resolution of global current account imbalances. Most of the uncertainties with respect to the Canadian outlook relate to how the economy is adjusting to the relative price changes associated with major global developments,” he said.

In a press conference following the report’s release, Dodge conceded the current political turmoil is not a positive for financial markets, as it adds uncertainty. However, he noted that it’s having no impact on the economy.

He added that a real change in policy direction as the result of an election could change things, but that this is impossible to predict.

Dodge declined to criticize the government’s move to adopt aggressive greenhouse gas emission reduction targets, in meeting its obligations under the Kyoto Accord. He suggested that similar environmental pressures are being felt everywhere, and will lead to greater hydrocarbon economizing, even if this comes as a result of Kyoto.

He conceded that cost pressures will face energy-intensive industries, but that these will exist in other countries, too.