By Kim Mackrael OTTAWA--The Bank of Canada cut its benchmark overnight interest rate by 25 basis points to 0.50% on Wednesday, citing a deeper-than-expected impact of the decline in oil prices and a sluggish recovery in nonenergy exports.
The central bank said it projects that Canada's economy shrank modestly in the first half of 2015, and said plunging business investment and weak exports led it to lower its growth outlook to 1.1% for the full year from the previous forecast of 1.9% expansion.
The Canadian economy shrank by 0.6% on an annualized basis in the first quarter of 2015 and the central bank estimates that it declined by 0.5% in the second quarter. Economists commonly define two or more consecutive quarters of negative annualized growth as a recession, but Bank of Canada Governor Stephen Poloz declined to use the term during a news conference on Wednesday, calling it unhelpful.
"But there's no doubt that we have worked our way through a mild contraction," Mr. Poloz said during a news conference on Wednesday.
Wednesday's decision marks the second time the Bank of Canada has cut its key interest rate this year. The central bank surprised markets in January with a quarter-percentage-point cut to 0.75%, which it called "insurance" against falling oil prices.
In its last policy review, published in April, the Bank of Canada projected that the Canadian economy would begin to bounce back in the second quarter on the strength of an anticipated rebound in nonenergy exports. On Wednesday, the central bank suggested it is still trying to figure out why nonenergy exports continue to show weakness, calling the trend "puzzling."
The pullback in Canada's energy patch is causing the economy to undergo a "significant and complex adjustment," the central bank said.
A significant slowdown in energy and commodity-dependent sectors means growth is resting more on Canadian household spending and the ability of Canadian companies to sell into a growing U.S. economy.
The central bank, however, projected a return to economic growth in the third quarter of 2015, which it said would be led by an improvement in nonresource sectors of the economy. Growth in the U.S. is also expected to increase demand for Canadian nonenergy exports, it said.
The bank said its estimates for economic growth have been marked down considerably from its last projection in April. An estimated 40% decline in business investment in Canada's important oil and gas sector for 2015 and weaker-than-expected nonenergy exports dragged down the economy and contributed to a contraction in gross domestic product during the first half of the year, it said.
"This was a justifiable rate cut," said Sebastien Lavoie, economist at Laurentian Bank Securities, citing the weak activity in nonenergy exports. "The bank cut rates in January as insurance against the crude decline, but it's now determined that the insurance wasn't enough."
Mr. Lavoie said the rate statement suggests the Bank of Canada has left the door open to another rate cut should conditions not improve, and inflation continues to remain tepid.
Ahead of the rate decision, a slim majority of investment banks projected a second cut based, in large part, on weak GDP and trade data that was released in recent weeks.
Seven out of 11 Canadian government securities dealers surveyed by The Wall Street Journal expected the central bank to cut the interest rate to 0.50%. Another four said they believed the Bank of Canada was more likely to leave the rate unchanged until it had more information about the economy's performance.
Mr. Poloz had projected that a low Canadian dollar and strengthening U.S. economy would help drive exports. The U.S. takes about three-quarters of Canadian exports.
The central bank said Wednesday that it estimates the underlying trend in inflation is 1.5% to 1.7%.
It said it anticipates the Canadian economy will return to full capacity in the first half of 2017, later than its previous projection for around the end of 2016.
The rate cut sent the Canadian dollar lower against the U.S. dollar. The Canadian dollar fell to around 77.5 cents from 78.2 cents just before the central bank's announcement.
Write to Kim Mackrael at kim.mackrael@wsj.com
(END) Dow Jones Newswires
July 15, 2015 14:49 ET (18:49 GMT)
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