The Bank of Canada’s latest Monetary Policy Report paints a gloomy picture of the outlook for the economy, calling for the weakness to persist throughout next year. It also signals that more rate cuts are coming.

In its report released today, the central bank notes that the U.S. economy is already in recession, it predicts that the global economy is headed that way, and it slashes the forecast for the Canadian economy in 2009 from 2.3% growth to just 0.6%. Overall, the Bank of Canada projects average annual growth in real GDP of 0.6% in both 2008 and 2009, before accelerating to 3.4% in 2010.

The Bank of Canada says it expects growth to be sluggish through the first quarter of next year, then to pick up over the rest of 2009 and to accelerate to above-potential growth in 2010 supported by improving credit conditions, the lagged effects of monetary policy actions, and stronger global growth. The recent sizable depreciation of the Canadian dollar will also provide an important offset to the effects of weaker global demand and lower commodity prices, it notes.

With excess supply projected to build throughout 2009, and with lower energy prices, inflationary pressures will ease significantly relative to the projection in the July Monetary Policy Report Update, the Bank of Canada predicts. Core inflation is now projected to remain below 2% until the end of 2010. Total CPI inflation should peak during the third quarter of 2008, fall below 1% in mid-2009, it predicts, returning to the 2% target by the end of 2010.

In line with the new outlook, the central bank indicates that “some further monetary stimulus will likely be required” to achieve the 2% inflation target over the medium term. “The evolution of the financial crisis, its impact on the global economy, and the timing of the effects of the various extraordinary measures being taken to address it pose significant risks to the inflation projection on both the upside and the downside,” it notes.

“Today’s MPR makes clear that the greater risks to the Canadian economy are with respect to weaker growth rather than to higher inflation,” observes RBC Economics. It forecasts the overnight rate dropping to 2.00% by the end of this year, adding, “If the central bank’s more negative assessment of growth in both Canada and the United States is realized, additional cuts in the overnight rate may be warranted.”

TD Economics says that “there is little point in delaying further easing”. It expects the Bank to cut by 50 basis points on Dec. 9, leaving the overnight rate at 1.75%. “There is certainly the risk that the ultimate floor for the overnight rate could end up below 1.75%, although anything below 1.5% would likely encounter some resistance unless the economic outlook weakens even further,” it explains.

Along with the deteriorating global economic outlook and declining commodity prices, the Bank notes that the intensification of the global financial crisis, and the looming deleveraging, is having a profound impact on the Canadian economy and contributing to uncertainty in the outlook for growth and inflation.

Regarding the financial crisis, the Bank of Canada says that the extraordinary measures designed to stabilize the financial system in other countries will help revive the flow of credit to support global economic growth. Canada’s economy and financial system will benefit directly from these actions, it suggests. Indeed, Bank of Canada Governor Mark Carney notes that most of the problems in the global financial system were created outside of Canada, and so most of the solutions must originate there too.

That said, Carney applauds the actions taken by the federal Finance department today to ensure banks have access to wholesale funding. He says that this was necessary in light of actions taken elsewhere to keep Canadian banks on a level playing field, but he also notes that it’s important that this new facility is being offered on commercial terms.

Carney also stresses the Canadian banks are well capitalized, and he dismissed the idea that the government should make capital available to the banks. He says that our banks are already at the “finish line” that other banks are pursuing in terms of their capital positions and leverage.