The Bank of Canada today announced that it is lowering its target for the overnight rate by one-quarter of a percentage point to 2.25%.

The operating band for the overnight rate is correspondingly lowered, and the Bank Rate is now 2.5%.

“The weaker outlook for global demand will increase the drag on the Canadian economy coming from exports,” the central bank said in a commentary. “Lower commodity prices will also dampen the outlook, working through a deterioration in Canada’s terms of trade to moderate domestic demand growth. The marked tightening in Canadian credit conditions in recent weeks will restrain business and housing investment.”

The bank expects average annual growth in real gross domestic product of only 0.6% in both 2008 and 2009, before moving up to 3.4% in 2010.

Easing inflation pressures also played into the latest rate cut. The bank said core inflation likely peaked in the third quarter of this year, and will fall below 1% in the middle of 2009, and then return to its 2% target by the end of 2010.

The Canadian dollar retreated in the wake of the cut. The loonie was down more than one cent at US82.68¢ in morning trading on currency markets.

Today’s rate cut followed a reduction of one-half of a percentage point on Oct. 8, when the Bank of Canada joined other world central banks in lowering borrowing costs.

Analysts had expected either a quarter-or half-point reduction in interest rates, but they maintain that the Bank of Canada will cut yet again this year.

RBC Economics noted that the Bank of Canada explicitly stated a bias to reduce the policy rate even more, saying that “some further monetary policy stimulus will likely be required” to keep inflation on target and highlighted that risks to the outlook, both upside and downside, remain “significant.”

“With credit conditions tightening, the U.S. economy in recession and commodity prices coming off the boil, the Bank downgraded the forecast for Canadian economic growth to 0.6% in both 2008 and 2009. This was a decisive cut to their July forecast of 1% in 2008 and 2.3% next year,” notes RBC, adding that the forecast for 2010 was inched up to 3.4% from 3.3%.

The Bank of Canada highlighted three developments that are negatively affecting the outlook for Canada’s economy — the “intensification of the global financial crisis,” signs that the global economy is heading into recession and the weakening in commodity prices, observes RBC.

“Although the Bank of Canada decided to move in a smaller step than we expected today, with the U.S. economy in recession and other global trading partners slowing, the Bank indicated that some additional easing may be necessary and we expect that it will cut the policy rate to 2% before year-end to shore up Canada’s domestic economy as the boost from the terms of trade weakens,” RBC concludes.

National Bank Financial economists argued for no rate cut today, but also sees rates going to 2% by year end. “Unless the global economy caves in unexpectedly and that financial conditions take a turn for the worst, we still believe that we are one modest rate cut away from a prolonged pause (i.e. 2% target rate through 2009),” it says.

According to TD Bank, the Bank of Canada reduced its forecasts for economic growth “by a startling degree”. It notes that as an inflation targeting central bank, the Bank of Canada relates all of this back to its outlook for inflation. “The deleveraging of financial institutions, the waning global outlook and falling commodity prices have all but removed any significant inflationary threats from the near-term horizon. The BoC now expects core inflation to remain below its target of 2% until the end of 2010,” it reports.

“The bottom line is with inflation threats diminishing and risks to growth increasing, the Bank of Canada’s decisions become easier. We continue to expect further easing, which along with other concerted actions by policy makers in Canada and abroad, should pave the way for an eventual recovery,” TD concludes.

BMO Capital Markets also said that it expects at least another quarter point cut on Dec, 9.

The central bank will publish the details of its new projection for the economy and inflation, including all the key risks to the projection, in the Monetary Policy Report on Oct. 23.