The Bank of Canada is lowering its target for the overnight rate by one-half of a percentage point to 1%, the central bank announced Tuesday.

That’s the lowest level since the central bank was formed in 1934.

The operating band for the overnight rate is correspondingly lowered, and the bank rate is now 1.25%.

The move was widely expected by Bay Street economists.

In its accompanying statement the bank said “Heightened uncertainty is undermining business and household confidence worldwide and further eroding domestic demand.”

“Major advanced economies, including Canada’s, are now in recession and emerging-market economies are increasingly affected,” the bank said.

“Canada’s economy is projected to contract through mid-2009, with real GDP dropping by 1.2% this year on an annual average basis,” it added.

Tuesday’s rate cut brings the cumulative monetary policy easing to 350 basis points since December 2007.

Economists at the Royal Bank of Canada expect the cut to help the economy emerge from slumping conditions.

“We expect the combination of historically low interest rates, past and upcoming fiscal stimulus and the weaker Canadian dollar to limit the extent of the weakening, with modest positive growth rates forecast for the second half of the year,” said assistant chief economist Dawn Desjardins.

A full update of the bank’s outlook for the economy and inflation, including risks to the projection, will be published in the Monetary Policy Report Update on Jan. 22.

The next scheduled date for announcing the overnight rate target is March 3.

Economists at Toronto-Dominion Bank expect the bank to cut the rate by another 50 basis points at the next announcement, and hold it there for some time.

“Given the considerable amount of remaining uncertainty and the fact that the Canadian recession has just started, the policy rate is expected to stay at this record low well into 2010 before inflation starts registering on the radar again,” wrote economist Pascal Gauthier in reaction to the announcement.

Shortly after the central bank’s announcement Canada’s big banks said they were cutting their prime lending rates.

Toronto-Dominion Bank said it was cutting its prime rate by 50 basis points to 3%. Other banks follow suited, dropping their prime rates to 3%.

IE