April 24, 2008 / 2:54 PM / in 10 years

Bank of Canada sees lower growth, flags inflation

OTTAWA (Reuters) - Canadian economic growth will plunge to 0.3 percent in the second quarter of this year from a previous estimate of 2 percent, while inflation will climb higher than expected this year, the Bank of Canada said on Thursday.

<p>Bank of Canada Governor Mark Carney listens to a question during a news conference upon the release of the Monetary Policy Report in Ottawa April 24, 2008. REUTERS/Chris Wattie</p>

In its Monetary Policy Report, the central bank said it now sees a marginal decline in the U.S. economy in the second quarter of this year, which will pinch Canadian exports and help depress Canadian growth. Canadian growth will recover in the second half to 1.8 percent and continue climbing in 2009, it predicted.

“With growth in imports expected to remain strong, net exports exert a larger drag on overall growth in 2008 than was the case in the last update (in January),” the bank said.

At the same time, the bank judges the underlying trend of inflation to be already at its 2 percent target even though the core rate that normally guides its interest rate decisions remains well below that level.

The bank sets interest rates to keep inflation on target in the medium term so any sign of creeping inflation could limit its current rate-cutting zeal. The bank cut rates by 50 basis points on Tuesday for a cumulative easing of 150 basis points since December.

It signaled further cuts were needed but refrained from indicating when it would make its next move.

So far, Canada has dodged many of the global food inflation problems plaguing the rest of the world because its strong currency has lowered import prices and helped trigger price wars among retailers.

Core inflation, which excludes eight volatile items such as gasoline prices and the effects of tax changes, has been heading lower and will remain well below 2 percent this year and return to target in 2010.

However, other measures of the underlying inflation trend were higher. Excluding only the effects of a cut in the federal sales tax, which went into effect in January, inflation would average just under 2.5 percent this year.

The bank suggested that one-off price discounts on cars due to the past appreciation of the Canadian dollar and the exclusion of rising mortgage interest costs from the calculation of core inflation may have kept that gage artificially low.

“The Governing Council judges that the underlying trend in inflation was about 2 percent in the first quarter,” it said.

Total consumer inflation will rise to 1.7 percent in the second quarter and 1.9 percent in the second half of this year compared to previous estimates of 1.4 percent and 1.5 percent, respectively, the bank said.

The turbulence in global financial markets will continue to make financing in capital markets more costly and difficult for Canadian businesses and banks this year, the bank said. Tight credit conditions will persist through 2008, easing by early next year and returning to more normal levels in 2010, it said.

Reporting by Louise Egan; Editing by Peter Galloway

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