Economic growth will stall in the second quarter of the year due to the U.S. slowdown and the global credit crunch, the Bank of Canada said Thursday.

In its monetary policy report, the central bank said economic growth for the April-June quarter will hit an annual rate of only 0.3%, down from a January expectation of 2% growth.

The bank also sees growth of 1.8% for the last six months of this year.

“The deterioration in economic and financial conditions in the United States will have significant spillover effects globally, particularly in the industrial economies,” the bank said in its quarterly outlook.

The U.S. economic malaise will push down Canadian exports until they begin to improve in the second half of this year and 2009.

Tensions in the world credit market are expected to persist through the rest of 2008 before starting to ease sometime next year. The central bank doesn’t see credit markets returning to normal until 2010.

The report comes just two days after the central bank cut a key interest rate by one-half of a percentage point to 3% in a move to stimulate the Canadian.

Conditions in Canada are expected to remain soft in 2009 — with the central bank forecasting first-half growth of 2.7%, and second-half growth of 3.3%.

The economy is expected to get back into balance in 2010, when the Bank of Canada sees growth of 3.4%.

At a press conference following the of the report, Bank of Canada Governor Mark Carney stressed that while credit conditions have tightened in Canada, this tightening has been much less dramatic here than in other markets.

He also noted that Canada has yet to see a real reduction in the availability of credit, which is a phenomenon that has emerged in other markets.

“It’s much better to be in Canada during this situation than in other major economies,” Carney said, because the increase in funding costs for Canadian banks has been much less than for banks in other parts of the world, and Canadian banks are better capitalized. The fact that the banks aren’t facing capital pressure means they can continue to make credit available, and indeed expand lending, he noted.

That said, he also indicated that there’s likely more tightening to come in Canadian credit markets too. Carney estimated that about two thirds of the impact of higher funding costs on the banks have been passed through to banks’ clients so far. “We think there’s more to come, unless their funding costs come down sharply,” he said.

The bank must factor the willingness, and ability, of banks to pass through its rate cuts to clients when setting monetary policy, he noted.

Continued deterioration is financial market conditions remains a downside risk for the bank, although Carney noted that some of the sorts of things that must be done to prevent that, are being done — notably disclosure is improving, and banks are raising capital. Moreover, the bank sees these downside risks balanced by several upside risks.

The report noted that markets are anticipating a further 25 basis point interest rate cut in Canada this year, but Carney said that number’s inclusion in the report does not suggest that the bank is validating that prediction.

Bay Street economists say that today’s report confirms the view that more rate cuts are likely coming.

TD Economics notes that the report echoed the tone and message set in the communiqué accompanying Tuesday’s 50 basis point interest rate cut. “Moreover, the details of today’s report confirm that more easing is likely in the pipeline; the question now is just a matter of when and by how much,” it says.

It suggests that Tuesday’s statement lowered market expectations of further cuts somewhat, “as analysts focused on several of the wording changes”.

However, TD says that, “Reading between the lines of the MPR, we believe that the case for continued monetary stimulus remains strong. The main thrust of the document is that worsening conditions in the domestic U.S. economy, working in combination with continued problems in credit markets, are expected to bring about a substantial slowdown in global growth.”

Additionally, TD suggests that the Bank of Canada’s forecast for an improvement to 2.4% growth in 2009 may be on the optimistic side, given that it doesn’t expect credit markets to fully right themselves until 2010. “In our view the slowdown in Canada is likely to be more protracted, with growth of 1.1% in 2008 improving to a less energetic pace of 1.8% in 2009,” it adds.

@page_break@BMO Capital Markets notes that the Bank of Canada reiterates that the risks to its outlook “appear balanced”, but it says, “the move from net downside risks at the time of the March 4 rate cut appears to have been as much to do about ebbing downside risks (partly owing to lower rates) as it has to do about augmented upside risks.”

“Indeed, the bank said that ‘global inflationary pressures… could spill over to Canada and lead to higher-than-projected inflation through increased costs for imports.’ This augments the standard worry about persistently strong domestic demand stoked by high commodity prices. The downside risks remain the trio of worries about the U.S. economy, credit conditions and the C$-damper on domestic prices,” BMO says.

“The bank has signalled that it might cut rates again depending on the data and evolution of risks. But the sense of urgency that was transparent last month has faded… think quarter-point move(s) and perhaps even skipped action down the road,” BMO concludes.

TD says that in its view, “the risks appear much less balanced and continued problems in credit markets point to the ‘evolution of the global economy and domestic demand’ strongly supporting a further half point of easing when the bank meets again on June 10.”