A rate cut from the Bank of Canada on March 2 is all but a done deal according to a new report from TD Economics. And there could be more cuts in the offing, depending on how inflation unfolds.

In a new report, Eric Lascelles, economist at TD Bank, looks at Canada’s inflation picture. He says that the Bank of Canada’s outlook is for core inflation to again drop under its 2% target as of January, and to remain there until late 2005. But, he says with all sorts of forces at play, it is important to contemplate alternative possible inflation pictures. “The Bank of Canada will certainly look through month-to-month blips. However, the fog of uncertainty surrounding Canada’s economic outlook still hangs thick and low,” he notes.

Statistics Canada reported today that consumer inflation plunged to a 1.2% annual rate in January, from 2% in December. That’s the smallest year-over-year increase in 20 months.

Economists call the big drop a statistical blip, with lower energy and car prices holding the CPI in check.

In his report, Lascelles suggests that on the low end inflation could be as low as 1.4% at the end of 2005. Or, in a hotter scenario, the output gap would be completely closed by the second half of 2004, and core inflation would rise to about 2.6% by the end of 2005.

“Of course, if either of these scenarios were to play out, the Bank of Canada would set about to counteract them by implementing appropriate rate adjustments,” he says. “However, monetary policy operates with a significant lag, and so the positive effects of the Bank’s actions would not be felt until well into 2005 — too late to significantly change inflation before early 2006.”

“On the whole, the Bank of Canada’s forecast for the economy is quite similar to our own estimation, and so we think the base case is certainly the most likely outcome, although there could be a few bumps along the way. And it is certainly refreshing to see that even in the worst-case scenario, core inflation does not depart from the Bank of Canada’s 1% to 3% target band for any sustained period of time,” he says.

“The implications for monetary policy are clear-cut. A rate decrease on March 2nd is now in the bag. Under the base case and the high scenario, that would be the last of the rate cuts, whereas under the low scenario, further cuts could be in the offing.”