TD Economics is predicting that the Bank of Canada will deliver a 25 basis point rate cut at its meeting next week, before moving to the sidelines. But TD foresees rate cuts resuming by the end of the year.

Next week’s rate decision is probably a closer call than we’ve seen for a while, TD says. It notes that there are arguments for a 50 bps rate cut, a 25 bps rate cut, and no move. It thinks the Bank will go for the middle path.

“The case for a 50 bps rate cut is not without merit, since we have seen a substantial amount of weakness in the Canadian economy since the last [rate decision],” it says. Including the fact that Canadian GDP declined outright in the first quarter of 2008.

“A case can also be made for the Bank of Canada to put an end to its rate cutting cycle, since credit conditions have improved to some degree since the Bank of Canada began cutting rates,” it allows, saying, “We think that the effect of the credit crunch is now likely less than the 50-75 bps that the Bank estimated in April.” The central bank may also be worried about inflation, TD adds.

Assimilating various comments from Governor Mark Carney, TD says it believes that, “Carney is seriously thinking about the upside risks from higher commodity prices, and that this will limit the extent of how much more cutting the Bank of Canada does in the near term.” With the market anticipating a cut already, it expects it to go with a modest 25 bps.

TD also predicts “significant changes” in the accompanying communiqué. It expects the central bank to abandon its hints at the need for further stimulus, saying that it will “act as needed,” to ensure that inflation will return to its 2.0% target in the medium term. “However, we don’t expect to see any indication of the timing or direction of the next rate move, since we believe that for the time being, the Bank of Canada would like to sit back and analyze the impact of the stimulus that it has already delivered,” it says.

“Although we think that the Bank of Canada will sit on hold for a while after June 10, we don’t think that this will be the last we hear from the Bank for 2008. We still expect to see further rate cuts, but not until the end of the year,” TD concludes. “We think that the U.S. economy is in for a lengthy period of little-to-no economic growth, with no real recovery in sight until well into 2009. With extremely weak demand from our biggest trading partner, we think that shrinking exports will keep the Canadian economy at a below-potential growth rate for some time, and that before the end of the year, the Bank of Canada will see that the recovery it had hoped for is not occurring. Consequently, we’re expecting to see two more 25 bps rate cuts in the last quarter of 2008, with the overnight rate ending the year at 2.25%.”