The Bank of Canada slashed its key interest rate by half a percentage point on Tuesday, as it warned of softer economic growth this year.

The cut reduces the bank's overnight rate — what big banks charge each other for overnight loans — to three per cent. The overnight rate hasn't been that low since December 2005.

Bank of Canada Governor Mark Carney has slashed rates by a full percentage point since he took over the top job in February.
(Dwayne Brown/Bank of Canada)

It's the second half-point cut in the last two months and brings the Bank of Canada's total rate reduction to 1½ percentage points since December 2007. Bank of Canada Governor Mark Carney has slashed rates by a full percentage point since he took over the top job in February.

The big banks were slow to lower their prime lending rates by a corresponding amount. But by late afternoon, they had all announced half-point reductions in their prime rates to 4.75 per cent, effective Wednesday.

A cut in the prime rate leads to immediate savings for those who have variable rate mortgages, lines of credit and other floating interest rate loans.   

Outlook reduced

The Bank of Canada has also reduced its outlook for economic growth, trimming its forecast to 1.4 per cent for this year. In January, the bank said it was looking for 2008 growth of 1.8 per cent.

The bank also trimmed its 2009 forecast by 4/10ths of a percentage point to 2.4 per cent. By 2010, growth is seen rising to 3.3 per cent.

"The bank is now projecting a deeper and more protracted slowdown in the U.S. economy," the Bank of Canada said in a statement accompanying the rate announcement.

"This has direct consequences for the Canadian economic outlook, with declining exports projected to exert a significant drag on growth in 2008. In addition, tightening credit conditions and softening sentiment are expected to moderate business investment and consumer spending."

The central bank will provide more details on its outlook for the economy on Thursday, when it releases its latest monetary policy report.

More rate cuts possible

The bank added that Canadian demand is projected to remain strong, supported by firm commodity prices, high employment levels and the effect of the Bank of Canada's interest rate cuts.

The central bank left the door open for more rate cuts if they are needed to keep the economy moving.

BMO Capital Markets economist Douglas Porter said the latest round of cuts may be drawing to a close, given the bank's aggressive actions.

"While we still look for another modest trim in rates at the next decision date in June, that may be the end of the line for rate cuts, especially if credit conditions begin to stabilize," Porter said.

TD Bank senior economist Richard Kelly said the central bank’s forecast for economic growth in 2008 and 2009 "seems optimistic."

"We continue to think that another [half-percentage point] cut at the next meeting on June 10 would be warranted given the balance of risks to the economy."