TD Bank’s economists say that the Bank of Canada will probably cut short-term interest rates by a tame 25 basis points at its next rate announcement date on May 29, but a more aggressive 50 bps move could be warranted.

“While the U.S. Fed’s aggressive action on the interest-rate front speaks volumes about the risks that lie ahead, the alarm bells do not seem to be ringing as loudly at the Bank of Canada,” said Marc Lévesque, senior economist at TD.

The Fed cut rates 50 bps at its last Federal Open Market Committee meeting, and maintained its bias towards easing. In contrast, the Bank of Canada has been confident that a significant pickup in U.S. economic growth in the second half of the year is in the cards.

“And there has been nothing in the most recent string of Canadian economic reports to sway the Bank from its upbeat view on the domestic economy,” noted Lévesque. “While it may be a tough call this time around, the odds lean towards a cautious approach from the Bank of Canada.” However, TD argues that it is not difficult to build a convincing case for the Bank to move more forcefully next week. “The U.S. economy is still not out of the woods, and a long, slow grind appears more likely than a second-half rebound. A half-point move on the 29th would be a good, and inexpensive insurance policy to take,” emphasized Lévesque.

TD economists still expect the Fed to continue to ease in the months ahead, trimming rates by a further 50 bps in two installments in June and August. “The Fed still has some work to do,” said Lévesque, “and the cuts will be matched by the Bank of Canada after next Tuesday’s move.”

The additional Fed easing that lies ahead is not fully priced into the bond market, noted TD, which should lead to modestly lower U.S. bond yields by the end of June. However, any rally will likely be limited, and short-lived, as the markets anticipate an eventual rebound in economic activity, which will send yields noticeably higher through the end of 2002.

While Canadian bonds have underperformed their U.S. counterparts in recent months, TD said current yield spreads are unsustainable. “While yields may be headed higher during the summer, Canadian yields will not rise as much as their U.S. counterparts,” noted Lévesque.