Bank of America forecasts another rate cut in Canada

Bank of America, one of the U.S.'s biggest banks, says the Bank of Canada may have to cut its key lending rate again later this year.

Bank of America says Canada's economy will underperform the U.S. this year, hampered by low oil prices and worries over manufacturing competitiveness.

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Already Canada is seeing investors move away from its bond and equity markets as they seek out a surer return in the U.S., the bank says.

Author Emanuella Enenajor says Canadian central bank governor Stephen Poloz is "handcuffed by the Fed," which is expected toraise rates later this year.

U.S., Canadian economies on different paths

"Even as the Fed begins a gradual rate hike cycle this year, we think the Bank of Canada will remain accommodative, and will likely ease by another 25 basis points to 0.5 per cent if growth disappoints, as we expect," she wrote in a report released today.

She points to a decoupling of the Canadian and U.S. economies, so that growth in the U.S., which is expected to be robust, will not have the stimulating effect on the Canadian economy it did in the early 2000s.

A 1 per cent increase in US domestic demand lifts Canadian GDP by about 0.25 per cent under current conditions. Ten years ago, the impact of that same one per cent rise would have been twice as much of an impact on Canada's economy,the report said.

Poloz has acknowledged weakness in Canada's economy in the first quarter, but expects a rebound laterin the year as exports grow because of U.S. demand.

Pressure on the Canadian dollar

Enenajor sees further pressure being put on the Canadian dollar, driving it as low as 73 cents by the end of the year.

"Although the C$ willease, the scope for persistent depreciation is limited given gradually recoveringoil prices. In sum, the growth headwinds due to tighter financial conditions willhandcuff the Bank of Canada in a state of continued monetary policy easing," the report said.

Complicating Canada's economic picture is a high current account deficit, high consumer debt and an increasing yield spread between Canadian and U.S. bonds.

Bond yields are already rising in Canada, with five-year Government of Canada bond yields up about 40 basis points in the last month. That could raise mortgage rates eventually, even as the central bank is forced to trim its benchmark rate, a move the Bank of America believes could come in October.