Central banks on both sides of the border cut interest rates today, and Bay Street economists are expecting more of the same in the months ahead.

As expected, the Bank of Canada lowered its target for the overnight rate by 25 basis points to 4%. The U.S. Federal Reserve Board surprised the markets however, with a 75 bps inter-meeting cut, taking its key rate down to 3.5%.

National Bank Financial notes that the cuts come in the context of deteriorating financial market conditions and prospect of a significantly weaker than expected U.S. economy. NBF says that the Bank of Canada’s decision reflects its view about domestic demand remaining strong in 2008 which should offset to some extend the stronger headwinds coming from south of the border. But, it also says that more rate cuts will be needed, “at this point in time our forecast is for the Bank to drop its target rate to 3.25% in 2008, but as usual that forecast will be data dependent”.

RBC Capital Markets agrees that the statement out of the Bank of Canada points to additional rate cuts ahead, especially if the U.S. economy remains under downward pressure. “Our baseline forecast is that the Bank will lower the overnight rate by another 50 basis points during the next couple of meetings with the risk of more aggressive rates cuts if the U.S. situation continues to deteriorate,” it adds.

TD Bank suggests that the Bank of Canada’s next move, on March 4, will be a more aggressive 50 basis point cut. “We believe that by the next meeting, data on the U.S. economy will provide a smoking gun, showing clear signs of a sharp economic slowdown. Given that inflationary pressures remain well in hand, a 50 basis point cut would provide much-needed insurance against the degree to which a U.S. economic downturn would lap onto Canadian shores,” it notes.

Following the March 4 meeting, there is the potential for another 25 basis point cut, TD adds. “However, given the degree of economic uncertainty on both sides of the border, the extent of additional easing will be highly dependent on how developments in the U.S. unfold and whether financial market confidence remains in question,” it notes.

BMO Capital Markets agrees that Canadian rates are headed lower, it predicts the Bank of Canada will eventually cut its policy rate to 3%.

RBC observes that the Fed signaled it is likely to cut again too, as, “appreciable downside risks to growth remain.” It says this would seem to suggest that the next reduction could come as soon as the next Fed meeting on January 29-30.

“Additional cuts beyond that point will depend on whether recent actions by the Fed are sufficient in reversing deteriorating financial markets. With the Fed of the view that inflation will ‘moderate in coming quarters’, the central bank is in a position to move aggressively if an easing in these pressures fail to materialize,” RBC concludes.