The Bank of Canada cut a key interest rate on Tuesday, dropping its target for the overnight rate by one-half of a percentage point to 0.5 per cent.

The rate cut had been widely forecast by economists. The bank has now reduced interest rates by four percentage points since it commenced the latest cycle of easing in December 2007.

The rate cut comes one day after Statistics Canada said the economy contracted at an annualized rate of 3.4 per cent in the last three months of 2008. The Bank of Canada had been projecting a 2.3 per cent rate of decline.

Monday's negative report left economists predicting a weaker first quarter this year, with annualized declines of five to six per cent forecast.

In its Jan. 22 update to its outlook on the Canadian economy, the Bank of Canada said real gross domestic product for 2009 is projected to decline by 1.2 per cent, followed by a rebound of 3.8 per cent in 2010.

Many critics charged the central bank's forecast was overly optimistic, but Bank of Canada governor Mark Carney has defended the outlook vigorously.

In the commentary accompanying Tuesday's rate decision, the central bank said data for the fourth quarter of 2008 and other indicators point "to a sharper decline in Canadian economic activity and a larger output gap through the first half of 2009 than projected in January."

Other measures considered

With the target for the overnight rate approaching zero, the bank also said Tuesday it is considering other measures to bolster the weak economy.

"Given the low level of the target for the overnight rate, the bank is refining the approach it would take to provide additional monetary stimulus, if required, through credit and quantitative easing," the bank said, adding that it would provide more details in its April monetary policy report.

That could turn the central bank into a buyer on credit markets in a bid to make corporate debt cheaper.

"Today's bold statement highlights [the] bank's nervousness that the typical policy tools will not be sufficient to put the economy back on a solid growth path," said RBC assistant chief economist Dawn Desjardins.

"The inclusion of the reference to quantitative and credit easing indicates that the bank is keeping its options open as it works to nurse the economy back to health and that policymakers here are ready to follow the lead of the United States, the United Kingdom and others in moving to more innovative ways to attack the problems," Desjardins said.

The move by the central bank to lower lending costs was quickly followed by several of the country's big chartered banks, as they cut their prime rates by one-half of a percentage to 2.5 per cent.