The Bank of Canada left a key interest rate unchanged on Tuesday but lowered its 2008 growth forecast for the Canadian economy.

As expected, the central bank left its overnight rate steady at 4.5 per cent, where it has been since a quarter-percentage point hike in July.

But the recent appreciation of the Canadian dollar against the U.S. dollar, coupled with an outlook for lower U.S. economic growth, will result in the domestic economy slowing down next year, the bank said.

Economic growth is expected to cool to 2.3 per cent in 2008 — down from its previous forecast of 2.6 per cent — before picking up to 2.5 per cent in 2009, the bank said. Growth in 2007 is expected to be 2.6 per cent.

The forecast for growth in the United States has also been revised downward, the bank said, to 1.9 per cent in 2007 and 2.1 per cent next year because of a greater-than-expected slowing in the housing sector.

The Canadian dollar was down almost two-fifths of a cent to close at just over $1.02 US. Some analysts said the bank's remarks suggest it could eventually be in a position to cut interest rates.

"For the first time in ages, the bank signalled a mild bias towards easing," said BMO Capital Markets economist Sal Guateri in a commentary, citing the bank's statement that the risks to inflation are "roughly balanced, with perhaps a slight tilt to the downside."

TD Bank deputy chief economist Craig Alexander said interest rates are on hold and he does not see lower rates "unless the downside risks start to play out."

RBC senior economist Dawn Desjardins sees the Bank of Canada standing pat on interest rates for another year. "We have pencilled in a move to 4.75 per cent in the fourth quarter of next year," she wrote. 

The Bank of Canada said it sees the overall and core inflation rates returning to its stated target of two per cent in the second half of 2008.

The annual core rate — which factors out some volatile elements — stood at 2.2 per cent in August, while overall inflation fell to 1.7 per cent after having been above the two per cent target since the spring.

The bank cautioned that excess Canadian consumer demand could persist longer than expected, which could boost the economy and spur inflation, but also noted that the increase in the Canadian dollar could take some steam out of domestic growth and rising prices.