Bank of Canada makes mild rate cut despite Fed move

OTTAWA (Reuters) - The Bank of Canada cut its key overnight interest rate by a quarter-point to 4 percent on Tuesday and said further cuts are likely to be needed to protect the economy from the worsening U.S. housing crisis.

But while warning that Canada's exports will be hit by the U.S. slowdown, the bank also emphasized the buoyancy of Canada's economy, projecting that high commodity prices will continue to boost domestic demand.

The move came shortly after the U.S. Federal Reserve slashed its benchmark rate by 75 basis points to 3.5 percent in a surprise meeting, creating a significant interest rate differential between the two countries.

In announcing the cut the Bank of Canada said: "The bank has decided to lower the target for the overnight rate and further monetary stimulus is likely to be required in the near term to keep aggregate supply and demand in balance and to return inflation to target over the medium term."

There had been some market speculation that the Bank of Canada would cut its rates by a heftier 50 basis points, especially after the rout in global markets on Monday.

The last time the bank cut rates by that magnitude was in the weeks following the September 11, 2001 attacks. The Bank of Canada prepared its rate announcement on Monday and opted not to adjust it at the last minute in reaction to the unexpected Fed cut.

"I would say as of about two hours ago, this decision wasn't a shock but it's interesting they stuck to a quarter-point move given the Fed's very aggressive move," said Doug Porter, deputy chief economist at BMO Capital Markets.

Hinting at revised projections scheduled for release on Thursday, the central bank said its 2008 outlook for the U.S. economy is now "significantly weaker" than the 2.1 percent it forecast in October. The Canadian economy will move into a situation of excess supply in the second quarter of this year, it said.

However, it said the economy is still running at above capacity despite slowing in the fourth quarter. The bank's quarterly business survey showed the portion of firms with some degree of difficulty meeting increased demand shot up to an all-time high of 60 percent in the fourth quarter, a sign of pressure on inflation.

Inflation projections are also being revised downward, with both total and core consumer inflation now expected to dip below 1.5 percent by mid-2008 before returning to the bank's 2 percent target by the end of 2009.

(Reporting by Louise Egan; Editing by Renato Andrade)