Despite the unexpectedly hot jobs report this morning, TD Bank says that the Bank of Canada should still cut rates 25 basis points on Wednesday.

TD Economics says the big downside risks are inflation, the strong dollar and the U.S. economy.

It note that core inflation been falling like a stone, “over the past seven months, the trend in core inflation has not been 2%, not 1%, but zero. In fact, the level of core consumer prices in August is a smidgen below the level recorded in February.”

With the stronger dollar and rising commodity prices, TD says Canadian economic growth will be slower, and the output gap larger, which would continue to nip any inflation in the bud. It also says the downward pressure through the import price channel would continue.

“The third factor is the U.S. economy,” says TD. “Based on the recent smattering of U.S. economic data – which has been mixed at best – the risk of a less-than-stellar U.S. performance next year is still alive.”

“There is one other piece of baggage the Bank of Canada would have to deal with if it were to decide to cut interest rates October 15. It would of course appear as if the cut was designed to influence the external value of the Canadian dollar.” But TD says a rate cut does not need to be seen as intervention in the exchange market.

“The case for a cut rests on the likely persistence of slack in the economy with the result that inflation may remain substantially below the Bank’s target for some time. It just happens that the strengthening Canadian dollar is an important determining factor.”

“Put it all together, and the ingredients for further easing are in place,” TD concludes. “Conversely, there is a significant — and mounting — risk that inflation could continue to tumble, especially with the Canadian dollar appreciating again. However, the consequences of not easing enough would be much more difficult to correct. Given the uncertainties that remain — the state of the U.S. economy, the remaining impact of the stronger dollar on consumer prices, and the path of the loonie itself — further easing would provide some insurance, and inexpensive insurance at that.”

http://www.td.com/economics/topic/ml1003_boc.html