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OTTAWA (Reuters) - The Bank of Canada slashed its benchmark interest rate by another half-percentage point on Tuesday to 3 percent as insurance against a steep U.S. economic downturn that threatens to engulf Canada.
Additional rate cuts are likely to be needed, the bank said, but it left open the possibility of a pause in its easing cycle as it stands back to assess the fallout from global economic woes before its next rate decision on June 10.
It dropped a previous reference that said it would have to lower rates in the "near term."
"Given the cumulative reduction in the target for the overnight rate of 150 basis points since December, the timing of any further monetary stimulus will depend on the evolution of the global economy and domestic demand, and their impact on inflation in Canada," it said in a statement.
Most market players had expected the 50-point cut as evidence mounts that the impact of the weakening U.S. economy is being felt in Canada, dampening exports and jobs growth.
But reaction was mixed to the more dovish tone on the bank's next move.
"It's as if the bank is signaling some sort of pause but then a pause is, in my view, not logical," said Carlos Leitao, chief economist at Laurentian Bank of Canada.
"If the economy needs further rate cuts then you do it."
Others remained confident the bank would reduce borrowing costs again on June 10, but only by 25 basis points and possibly for the last time.
"We have another 25 (basis points) to go and it doesn't look like that runs in contrast to the underlying tone of the release," said Craig Wright, chief economist at Royal Bank of Canada.
It was the second successive 50-basis-point cut to the bank's overnight target rate, making this its most aggressive round of rate cuts since the period following the September 11, 2001, attacks on the United States.
More details on the bank's thinking will be available on Thursday when it releases its new economic projections.
The Canadian dollar fell after the announcement, slipping to C$1.0120 to the U.S. dollar, or 98.81 U.S. cents, from C$1.0061, or 99.39 U.S. cents, beforehand.
The bank said its outlook for the U.S. economy has deteriorated since January and this will exert a "significant drag" on Canadian growth in 2008.
"The bank is now projecting a deeper and more protracted slowdown in the U.S. economy," it said.
Canadian domestic demand will remain strong but business investment and consumer spending will "moderate" due to tighter credit conditions and softer sentiment, it predicted.
Governor Mark Carney, a former Goldman Sachs banker who has headed the bank since February, had said in previous remarks that his focus when setting rates would be on the speed and vigor of the U.S. recovery.
The U.S. Federal Reserve has cut its benchmark lending rate by 3 percentage points since mid-September to 2.25 percent and Wall Street expects the Fed to cut again at its next scheduled meeting at the end of April.
The Bank of Canada also cut its forecast for 2008 Canadian growth to 1.4 percent from a January forecast of 1.8 percent. It now sees 2009 growth at 2.4 percent, down from 2.8 percent. Growth will recover in 2010 to 3.3 percent, it said.
It believes underlying inflation to be a bit higher than official numbers say, suggesting that it will ignore one-time price discounts caused by the past appreciation of the Canadian dollar versus the U.S. dollar.
Core inflation, which strips out volatile items and the effect of tax changes, slowed in March to 1.3 percent, its lowest since 2005. But the bank said it sees underlying at about 2 percent.
It also nudged back the time frame for inflation to move back up to its 2 percent target to 2010 from end-2009 and for the economy to move back into balance to mid-2010 from early 2010. It said the economy was operating above capacity now but would move into excess supply in the second quarter of 2008.
Additional reporting by John McCrank and Frank Pingue in Toronto; Editing by Peter Galloway