TD Bank economists are calling for the Bank of Canada to cut rates 50 basis points in the coming months.

“The Bank of Canada is in a tough bind,” said TD chief economist and Don Drummond and senior economist Marc Lévesque on in a report released Tuesday.

Just two months ago, the central bank raised rates and signaled that more hikes were coming. “But all that has changed, and the change has come blindingly fast,” the economists say.

The pair note that inflation has subsided, the outlook for the Canadian economy has “soured dramatically”, and the Canadian dollar has surged to almost US75¢. “And, last but not least, a rate cut from the U.S. Federal Reserve at next week’s FOMC meeting is a done deal, with a 50 basis-point move now a good bet.”

The pair argue that this gives the Bank of Canada good reason to lower intererst rates. “In our view the answer is yes. The economic headwinds against which the Canadian economy is struggling have become strong enough to constitute a significant drag on the Canadian economy through the remainder of this year. As a result, enough excess slack is likely to open up to shelve any inflation worries until well into 2004.”

They predict that the Bank will lower rates by 50 basis points — 25 at each of its next two meetings on July 15 and September 3.

In a separate release, Standard & Poor’s said Wednesday that it also expects the Bank of Canada to cut rates 50 bps by the end of 2003.

In a new report S&P notes that recent monetary policy actions by G-7 central banks suggest that downside risks to Canada have worsened recently instead of eased, “notwithstanding the quick resolution to the military conflict in Iraq and some easing in energy prices.” The U.S. Federal Reserve is expected to cut rates next week, the European Central Bank has recently cut interest rates, and the Bank of Japan has taken “the unprecedented step of targeting corporate debt as it seeks to build confidence and augment its program of bond purchase operations to inject liquidity into the economy”.

“Needless to say, with other G-7 central banks still in easing mode and likely to maintain an easing policy bias for a longer period of time than previously assumed, Canada’s major trading partners will not be providing much in the way of major upside impetus to the Canadian economy in the near term,” it says.

Rate cuts in Canada are not a slam dunk however. S&P notes, “Unlike the U.S. where there is a lot of excess capacity, the Canadian economy is operating in a position of little excess supply. Unless downside pressures on the economy turn out to be far worse than currently expected and pronounced disinflationary forces emerge, the case for a significant lowering of interest rates is not so compelling.”

However, it points out one reason for the Bank of Canada to consider lowering short-term interest rates is the appreciation of the Canadian dollar. “With the global economic recovery proving slow to gain traction, and with Canada’s trade sector facing a number of new challenges due to the outbreak of disease, a monetary policy response from the Bank of Canada would help the economy as it shifts to a stronger currency,” it says. “Until now, expectations of widening Canada-U.S. interest-rate differentials have contributed to the meteoric rise in the value of the Canadian dollar. A partial takeback of the 125 basis points worth of interest-rate hikes from the Bank of Canada since April 2002 would, therefore, have the benefit of stanching expectations of widening Canada-U.S. interest-rate differentials, leading to a more measured pace of appreciation in the Canadian dollar.”