OTTAWA -- The Bank of Canada cut its key interest rate Wednesday as it slashed its outlook for the economy and predicted a pullback in the second quarter due to the impact of lower oil prices and weaker-than-expected exports.
The central bank cut its target for the overnight rate by a quarter of a percentage point to 0.5 per cent.
The Bank of Canada said its lower outlook for growth has increased the downside risks to inflation.
"While vulnerabilities associated with household imbalances remain elevated and could edge higher, Canada's economy is undergoing a significant and complex adjustment," the bank said in its rate decision.
"Additional monetary stimulus is required at this time to help return the economy to full capacity and inflation sustainably to target."
By cutting its overnight rate target, the Bank of Canada is hoping to give the economy a boost by making it cheaper for consumers and companies to borrow money.
TD Canada Trust responded Wednesday by cutting its prime rate by a tenth of a percentage point to 2.75 per cent, effective Thursday, lowering the amount charged on loans tied to the prime rate including variable rate mortgages and lines of credit.
A contraction by the economy in the second quarter would mean the country slipped into a recession in the first half of the year, but the Bank of Canada did not make that distinction, noting that the downturn was focused in the energy sector.
In its monetary policy report, the Bank of Canada forecast the economy contracted at an annual pace of 0.5 per cent in the second quarter compared with its April forecast for growth at a pace of 1.8 per cent.
The drop follows a contraction at an annual pace of 0.6 per cent in the first three months of the year compared with the bank's prediction of a flat quarter.
However, the central bank predicts gross domestic product will grow at an annual pace of 1.5 per cent in the third quarter followed by 2.5 per cent in the last three months of the year. That compared with its earlier forecast for growth of 2.8 per cent and 2.5 per cent for the third and fourth quarters respectively.
For all of 2015, the Bank of Canada is now forecasting growth of 1.1 per cent, down from its earlier forecast of 1.9 per cent, while 2016 is expected to see growth of 2.3 per cent, down from 2.5 per cent.
The bank said several factors point to a resumption of growth in the third quarter, helped in part by the retroactive child-care benefit cheques Ottawa is poised to send out later this month.
"Importantly, exports are projected to return to solid growth, supported by continued improvements in U.S. demand and a rebound in automotive exports following temporary shutdowns for retooling at the beginning of the year," the bank said.
"Business investment will remain a source of drag, however, as the energy sector continues to adjust to low oil prices."
The Bank of Canada estimated that investment in the oil and gas sector will contract by close to 40 per cent this year, compared with an earlier estimate of about 30 per cent.
The rate cut is the second time this year the central bank has reduced its target for the overnight rate.
The Bank of Canada unexpectedly cut the rate in January by a quarter of a percentage point as what it called "insurance" to cushion the impact of the drop in oil prices on the economy. However, the economy contracted in each of the first four months of the year, leading to speculation that Canada slipped into a recession in the first half of the year.
The International Monetary Fund slashed its forecast for Canada last week to just 1.5 per cent compared with its earlier prediction of 2.2 per cent.
In its business outlook survey last week, the Bank of Canada observed a divide in business confidence across the country as low oil prices weigh on the outlook for some regions more than others.
The summer edition of the report suggested businesses on the Prairies will be hurt as the oil price shock spreads across other sectors. But the Bank of Canada said the story isn't the same across the country, with regions that are less exposed to the energy sector expected to show strength.