The Bank of Canada says the current recession will be followed by a faster recovery than usual.

In its Monetary Policy Report Update for January, which was released Thursday, the central bank projects Canadian GDP will decline by 1.2% this year, but will rebound by 3.8% in 2010.

In the U.S., the Bank of Canada expects GDP to decline by 1.7% in 2009, followed by a rebound in 2010.

The central bank also sees core inflation easing throughout 2009 in Canada, ultimately reaching a low of 1.1%, while total CPI inflation is expected to dip below zero for two quarters in 2009. It expects that inflation will return to its 2% target by mid 2011.

In a press conference following the release of the report, the Bank of Canada governor Mark Carney, indicated that the possibility of deflation is very unlikely in Canada. He noted that the bank worries about inflation falling below its 2% target as much as it does rates rising above the target, and he stressed that it has taken aggressive monetary policy action to fight the deteriorating conditions.

This action should help the economy climb out of recession faster than usual, Carney said. Normally an economy heads into recession with rates at 4%-5%, he suggested, but this times rates are already near zero. Add in stimulative fiscal policy efforts, which has a multiplier effect, and demand will eventually rebound. Carney added that fiscal efforts in other countries should also help Canada by boosting external demand and supporting commodity prices (Its’ outlook assumes an 82¢ dollar, energy prices in line with current futures prices, and a slight easing of non-energy commodity prices, accompanied by tight global credit conditions throughout 2009.

RBC Economics says that the report “incorporates a significant amount of bad news for Canada’s near-term economic performance, although it retains optimistic that both fiscal and monetary policy actions and support from the weaker Canadian dollar will set the course for a recovery in the second half of the year.”

While rates are already at a rock bottom 1%, Carney indicated that the Bank of Canada still has flexibility and various other policy tools that can be used to help underpin the recovery. If the bank moves to adopt other sorts of actions to revive the economy, he stressed that it will do so in an open, transparent manner. “We won’t sneak up on you,” he said.

“With the policy rate already at an extremely low level, we think that the data would have to severely disappoint the bank’s rather dismal outlook before policymakers would embark on a policy mirroring the Fed’s shift to quantitative easing,” adds RBC.

The biggest uncertainty facing the Bank of Canada’s outlook is the stability of the global financial system, Carney noted. The bank said that the stabilization of the system is a prerequisite for economic recovery. “To that end, governments and central banks are taking bold and concerted policy actions. There are signs that these extraordinary measures are starting to gain traction, although it will take some time for financial conditions to normalize,” it said.

RBC says that the bank’s assertion that policy is starting to gain traction provides “a glimmer of hope” that the economy is now treading through the worst. “Our baseline view remains that the overnight rate will be held at 1%,” it says, although it allows that the door to more rate cuts remains open, if the economy’s decline appears to be more acute or longer lasting.