Canada cuts growth forecasts as Europe, U.S. sag

Star performer Canada cut economic growth forecasts sharply on Tuesday as troubles abroad hit exports and dampened confidence about a recovery touted as the strongest in the G7.

An expected brief recession in the euro zone and more weakness in the U.S. economy prompted the Bank of Canada to delay by 18 months its forecast of when the economy will recover to full capacity. The bank left its key interest rate unchanged at an unusually low 1 percent and took any prospect of an interest rate hike completely off the table.

Separately Finance Minister Jim Flaherty downgraded the growth assumptions to be used in budget projections next month and spoke more openly than before about the possible need for additional stimulus if the economy stumbled again.

We're of course concerned that we could have external events damage our economic growth to the point where other measures would be necessary within Canada, particularly with respect to jobs, Flaherty told reporters.

Ottawa, which bases its outlook on the average of 15 private sector forecasters, sees the economy growing 2.2 percent this year, down from a 2.9 percent forecast in June, and 2.1 percent in 2012 compared with 2.8 percent previously.

The central bank's outlook varies slightly but both now see growth at closer to 2 percent than 3 percent until 2013.

Still, that outlook is hardly doom and gloom and barring an economic catastrophe stemming from Europe, Flaherty said there will not be another recession. Most of the countries in the world would gladly change places with Canada, he said.

Canada had one of the mildest recessions in the Group of Seven rich nations and as of January recovered all the jobs lost in the downturn.

But now some of the gloss is coming off that performance, and policy makers lay the blame on other countries.

The Bank of Canada's statement focused heavily on setbacks in the global economy and said modest domestic demand would drive growth.

If I'm just adding up the words here, more talk about the global economy than the domestic economy, which itself perhaps sums up where the net risks to Canada really lie, said Michael Gregory, senior economist at BMO Capital Markets.

The bank's dovish tone means investors have increased the chance of a rate cut in the coming year, although the bank made no suggestion of easing. The Canadian dollar hit a session low.

Bank of Canada Governor Mark Carney said this month the bank won't be trigger happy, but has room to cut rates if needed.

The bank now sees inflation returning to its 2 percent target at the end of 2013 rather than in mid-2012, as it forecast in July. Inflation was an above-target 3.2 percent in September, but the bank sees the rate declining to 1 percent by the middle of next year before bouncing back.

Canada's central bank was the first among advanced economies to raise interest rates after the global financial crisis, lifting the rate three times in mid-2010. It has been on hold since then, and nobody expected a move on Tuesday.