The continued economic slowdown in the United States will likely mean further interest rate cuts from the Bank of Canada, the central bank’s second in command confirmed today.

“The most immediate challenge facing the global economy is the marked slowdown in the U.S. economy,” Bank of Canada deputy governor Paul Jenkins told a London, Ont. audience this morning. “This slowdown involves several interconnected elements, and, given our close trade links to the United States, has very direct consequences for Canada.”

Jenkins noted that some slowing in global economic growth was necessary and “levels of economic activity around the globe were straining capacity limits and beginning to put upward pressure on inflation.”

He re-emphasized the Bank’s focus on keeping inflation low, stable and predictable. He said Canada’s strong domestic demand has thus far offset a weak export market. “Monetary policy has been calibrated based on judgments about the relative strengths of these competing forces, with an eye firmly fixed on the policy objective of keeping inflation at our 2% target,” he said.

At the moment, total CPI inflation in Canada is 1.8% and excluding the one-time effect of the January GST cut, it is 2.4%, while core inflation—which excludes the more volatile factors such as energy and food—is 1.5%.

Jenkins said the correction in the U.S. housing markets and the spreading to other part of the U.S. economy coupled with tight credit conditions throughout the world means “the risks surrounding the Canadian economy have shifted to the downside, resulting in [the bank’s] decision to lower our policy interest rate by 50 basis points to 3.5%.”

He then reminded the London Chamber of Commerce audience that “further monetary stimulus will likely be required in the near term to keep aggregate supply and demand in balance and to achieve the 2% inflation target over the medium term.”

The whole meltdown in the U.S., which is by no means over, can be seen as an “overdue repricing of risk, a recognition of losses, and a recapitalization of balance sheets,” Jenkins added.

In general, he said the global economy, and by extension Canada’s, faces three key challenges: the slowdown of the U.S. economy and the associated financial turbulence, global trade imbalances and competition from emerging-market countries.

As far as solutions go, the deputy governor suggested the private sector needs to increase transparency in financial products, improve risk and liquidity management and develop more rational, better-aligned incentives.

To readjust the trade surplus problem, the he said countries with large surpluses need to rely more on domestic demand as a source of growth, and those with deficits (mainly the U.S.) need to increase their national savings rate. And, he added, exchange rate flexibility needs to be beefed up.

As competition from developing economies intensifies, Jenkins believes the growth of emerging-market economies represents a tremendous opportunity for Canadian businesses, rather than a threat. “We need to exploit our comparative advantages and see these rapidly expanding markets as places to do business,” he said.

As for the struggles that Ontario is facing, particularly in its manufacturing sector, Jenkins said it points to “the need for adjustment within the Ontario economy.”

Overall, he said it’s important for Canadians to remember that market-based adjustment mechanisms are vital and price signals will help decision-making. He stressed the importance of policies that encourage initiative and innovation.

“The global forces at play are not going to disappear any time soon,” he said. “We therefore need to encourage flexibility and adaptability in the Canadian and Ontario economies. In other words, more needs to be done to enhance the functioning of our internal markets.”

The Bank of Canada’s next interest rate announcement is scheduled for April 22.