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Bank of Canada slashes interest rates

KEVIN CARMICHAEL

Globe and Mail Update

March 4, 2008 at 9:12 AM EST

OTTAWA - The Bank of Canada dropped its key lending rate by half a percentage point, and indicated that further cuts will be needed to insulate Canada from the effects of a U.S. economy that teeters on the brink of recession.

"The deterioration in economic and financial conditions in the United States can be expected to have significant spillover effects on the global economy," the central bank said in its statement Tuesday.

"Further monetary stimulus is likely to be required in the near term to keep aggregate supply and demand in balance and to achieve the 2 per cent inflation target over the medium term", the bank said.

Mark Carney's first policy decision as governor left the Bank of Canada's benchmark interest rate at 3.5 per cent. The central bank last reduced borrowing costs by a half point in November 2001 and has adjusted interest rates by that magnitude only four times since moving to a fixed announcement schedule in March 2000.

Mr. Carney and his five deputies on the Governing Council next fix interest rates on April 22.

The decision by the central bank to get more aggressive after quarter-point reductions in December and January shows policy makers doubt Canada's strong domestic economy will hold up next to weaker demand from the country's largest trading partner.

Canada's gross domestic product grew 0.8 per cent in the fourth quarter, the slowest in 4 ∏ years and half as much as the Bank of Canada was expecting. The U.S. economy, which consumes some 80 per cent of Canada's exports, was even weaker in the fourth quarter, advancing at a 0.6 per cent annual rate.

"There are clear signs the U.S. economy is likely to experience a deeper and more prolonged slowdown than had been projected in January," the central bank said in the statement, citing the housing market, which is suffering the biggest collapse in generation. "These developments suggest that important downside risks to Canada's economic outlook that were identified in (January) are materializing and, in some respects, intensifying." The Bank of Canada sets interest rates to keep inflation advancing at about 2 per cent a year, and uses a measure that strips out volatile prices such as energy to predict where costs are heading.

Canada's core rate of inflation was 1.4 per cent, leaving plenty of room for today's half-point cut, economists said before the announcement.

While conceding that Canada's domestic demand remains "buoyant" and that companies were producing above capacity, policy makers determined the bigger worry is economy won't generate enough activity to keep inflation at its 2 per cent target.

"The bank now judges that the balance of risks around its January projection for inflation has clearly shifted to the downside," the Bank of Canada said.