The Bank of Canada has sharply lowered this year's growth forecast for the Canadian economy, citing spillover from the slowdown south of the border.

In its latest monetary policy update issued Thursday, the central bank now says GDP will rise by 1.8 per cent in 2008, down from its October estimate of 2.3 per cent.

David Dodge holds his last news conference Jan. 24 after seven years as Bank of Canada governor. Mark Carney takes over at the end of the month.
(CBC)

"We will come through 2008 fine," Bank of Canada governor David Dodge said at a news conference. "It won't necessarily feel so fine, but we will come through it, in retrospect … fine. But there's a lot more adjustment still to come."

The new forecast calls for annualized growth of just 0.6 per cent in the first quarter — down from a previous estimate of two per cent. That improves to two per cent in the second quarter and an average of 2.3 per cent in the second half of the year.

The Bank of Canada said exports to the U.S. are expected to be much weaker than forecast just three months ago, as the U.S. economic outlook darkens amid a severe slump in housing and tightened credit conditions.

"Declining activity in the U.S. housing sector suggests a deeper and more prolonged adjustment in U.S. residential investment and a reduction in home equity values," the bank said in its forecast.

According to its revised forecast, weak U.S. household spending and residential investment will cause U.S. growth to be "particularly weak" in the first half of the year, averaging just 0.5 per cent on an annualized basis.

As a result, Canadian GDP growth this year will largely be a result of home-grown demand, the central bank said — noting that commodity prices should remain high, real incomes should enjoy "robust growth" and interest rates will be lower.  

Ups 2009 forecast  

The Bank of Canada forecasts that U.S. GDP growth will start to pick up later in 2008 and in 2009, and with it, the outlook for Canadian exports will improve.

So the bank has raised its Canadian growth outlook for 2009. Previously, the Bank of Canada was forecasting growth of 2.5 per cent next year. It now sees growth over the year of 2.8 per cent.

The bank says both core and total CPI inflation are projected to fall below 1.5 per cent by mid-2008 before returning to two per cent by the end of 2009.

Earlier this week, the central bank cut its key overnight lending rate by a quarter of a percentage point to four per cent. It also signalled that further interest rate cuts were likely — a comment that was reiterated in its policy update Thursday.

Some analysts said the central bank seems unlikely to slash rates dramatically, as the U.S. Federal Reserve did on Tuesday when it cut its key policy rate by three-quarters of a percentage point.

"There is little in today's monetary policy report update to hint that they are poised to come close to matching the very aggressive cuts seen from the Fed," said BMO Capital Markets economist Doug Porter.

He noted that Dodge suggested during his news conference that cutting rates "in a measured fashion is the right way to go."

The next scheduled interest rate announcement comes on March 4. The new Bank of Canada governor, Mark Carney, will preside over that announcement, as Dodge heads into retirement at the end of January, after seven years at the helm. Dodge said he plans to go sailing.