Merrill Lynch has lowered its forecast for the Canadian economy, it now sees a 3% decline in GDP this year.

In a research report released Wednesday, the firm notes that the downward revision marks its third such move since mid-December. “While the revisions reflect broadly faster-than-expected deterioration in the macro environment, four specific developments are of primary importance – the fall in our 2009 global growth forecast to -0.5% from 0.4%, the rise in our end-2009 USD-CAD forecast from $1.27 to $1.35, the extension of Canadian inventory and housing stock overhangs through Q4, and more-intense-than-expected weakness in core areas of private domestic demand.”

The latest downgrade for 2009 takes Merrill’s real GDP forecast to -3% from -2.1%, reflecting downward revisions to capital expenditures, consumption and inventories, with only mild offset from stronger government spending and net export profiles, it says.

Merrill’s 2010 forecast is little changed, calling for a sluggish rebound of 2.2%. “Our base case does not foresee Canada’s economy regaining its Q3 2008 peak until well into 2011 — an extended period of sub-par economic performance despite the ostensible ‘recovery’ in 2010,” it says.

“Our forecasts have long expected the Bank of Canada to move rates to ‘effective zero’ and keep them there for an extended period; combining last week’s confirmation from the central bank with the downgraded economic forecast pushes the prospective normalization in rates into 2011,” it adds.

“Our Canadian bond market view remains bullish on balance, with the supportive effects of lower-for-longer overnight rates and prospective quantitative easing measures offsetting a (supply-driven) less constructive view on Treasuries from our U.S. colleagues,” the report says.

Merrill also lowered its forecast for TSX earnings, and has cut its 2009 target for the S&P/TSX composite index to 6,900 down from its prior call of 8,000.