The U.S. economy is now in recession, according to a revised forecast released today by BMO Capital Markets.

“The marked and widespread deterioration of business, consumer and investor sentiment since the start of 2008 has prompted us to revisit and revise our forecast,” says the report, called “Recalibrating the Forecast.”

The report points out that housing markets continue to decline, credit conditions are still tightening, unemployment is rising, retail sales are slumping and rising energy prices are curbing household spending. “Investment is poised to slow, with confidence among business leaders hitting recession lows and machinery orders pulling back recently.”

The report concludes: “All in, the U.S. economy likely slipped into a modest recession around the turn of the year.”

The economists at BMO are expecting U.S. GDP to contract about 1% in the first half of this year, and then, according to the report, easier monetary policy and steadier housing markets will bring on some gradual improvements in the second half of the year and into next.

“We look for Bernanke & Co. to cut the fed funds target further from 3.5% today to 2% by the middle of this year,” reads the forecast. “Once the Fed stops easing, yields should begin drifting up, although meaningful increases will be reserved until the Fed starts signaling its intention to resume normalizing policy rates (not until the spring of 2009).”

The Royal Bank of Canada agrees that continued rate cuts can be expected from the Fed, and has also revised its previous forecasts. “We expect the Fed to lower the funds rate to 2% with three 50 basis point rate cuts forecast at each of the next three meetings including January 29/30,” it said.

BMO is also expecting the Bank of Canada follow the Fed’s lead on rate cuts, predicting further quarter point cuts and perhaps a 50-point easing through the middle of the year. “Wider Canada-U.S. overnight rate spreads (from 50 bps to 100 bps) will reinforce the tendency for Canada bonds to lag their U.S. counterparts in a declining-yield environment,” says the report. “However, the Canadian bond market heads into U.S. recession with much more favourable fiscal and inflation trajectories, which should contribute to relative outperformance in the eventual reverse trade.”

BMO says that a healthier housing market, strong government finances and the commodity boom will help the Canadian economy avoid its own recession.

The renewed BMO forecast sees Canadian GDP growth at 1.4%, 0.8% less than previous outlooks, and at 2.0% by 2009. As well, the Canadian unemployment rate is now expected to rise to 7% by late this year from 5.9% at the end of 2007, according to the report.

RBC’s forecast is also calling for less than 2% GDP growth in Canada. “We are forecasting real GDP growth will average 1 to 1.5% in the first six months of the year,” it now says. RBC expects rate cuts from the Bank of Canada of 100 basis points by the end of the second quarter and says that a 50-point cut is likely on March 4.