In its latest update to the Monetary Policy Report, the Bank of Canada says that both economic growth and inflation are expected to be weaker than earlier forecast.

The July update to the April report was released on Thursday.

Growth in the third quarter is now expected to be somewhat lower than the 2.5% that was anticipated last April. However, the Bank expects that growth in Canada’s economy will strengthen towards the end of 2003 and through 2004. It is projected to pick up to the 3% in the fourth quarter and to gather further strength over the course of 2004. “Growth during 2004 will likely be higher than previously projected, suggesting that the economic slack that is expected to develop in 2003 will be largely absorbed by the end of next year,” the Bank says.

This outlook implies real GDP growth, on an average annual basis, of about 2% in 2003 and just over 3% in 2004.

As for inflation, the Bank says that it now appears that, by the end of this year, core inflation will fall below the 2% target.

The update highlights a number of unanticipated developments that have changed the outlook for economic activity and inflation in Canada. Inflation has eased, domestic demand has been hit by SARS and mad cow disease, and foreign demand has been weaker than expected.

The update notes that the substantial rise in the value of the Canadian dollar against the U.S. dollar will have a dampening effect on the future growth of demand for Canadian goods and services. “As a result, more slack is developing in the economy than was previously expected.”

In reaction to the update, economists are predicting another 25 basis point cut to interest rates in September.

Bank of Montreal says that the update suggests the Bank of Canada is “predisposed to ease in the absence of a solid pickup in economic activity in the months ahead”.

Regarding the Bank’s revised growth and inflation outlook. BMO notes “This is a sharp reversal in view from earlier in the year when the Bank warned of broadening price pressures, though the shift is justified by the sharp and largely unforeseen deterioration in economic conditions since then.”

Notwithstanding the gloomy report, BMO says that it expects the Bank to hold rates steady as growth in both Canada and the US picks up. “However, any slippage in the data or strength in the currency could spur another rate reduction,” it allows. “We expect rates to remain steady until the spring of 2004, before rising gradually to a more neutral level.”

RBC Financial says “With the Bank’s core inflation projection now slightly below the mid-point of the 2% target right through to mid-2005, another rate cut in September is likely.”

TD Bank agrees, saying that the revised view on inflation is the big news. “Putting it all together, a further cut to the Bank of Canada’s overnight rate cannot be ruled out beyond September, particularly if expectations for the long-awaited rebound in U.S. economic growth fail to materialize and if the negative fallout from the strong loonie proves harsher than anticipated,” comments TD senior economist, Derek Burleton.

BMO Nesbitt Burns chief economist, Sherry Cooper, says, “We continue to steadfastly believe that the North American economy is poised for a second-half rebound. However, the Bank’s clear dovish view on the inflation outlook suggests that they will have an itchy trigger finger on rate cuts rather than giving growth the benefit of the doubt.”