By Greg Quinn

Jan. 22 (Bloomberg) -- The Bank of Canada said the economy will recover from a recession this year more quickly than in the past as credit markets and exports rebound, a view that economists said may be too optimistic.

The central bank slashed its economic growth forecast for the first quarter, saying output will shrink at a 4.8 percent annualized pace after predicting in October that it would be unchanged. Gross domestic product will shrink at a 1 percent rate in the second quarter before growing 3.8 percent next year, almost double the median pace in a Bloomberg survey of economists.

“The projected return to balance of the Canadian economy is faster than either of the recoveries following the 1981-82 and 1990-92 recessions,” the Ottawa-based central bank said today in an update to its October Monetary Policy Report. “Canadian credit conditions remain better than those in other major countries” and “exports are also expected to recover next year,” the bank said.

Governor Mark Carney two days ago cut borrowing costs by half a point to 1 percent, the lowest since the central bank was founded in 1934, and said he would “carefully” assess how much more stimulus may be needed. The world’s eighth-largest economy is shrinking because of slower foreign orders for goods such as cars and commodities such as crude oil, combined with the global credit crisis which has made banks reluctant to lend. The next rate decision is scheduled for March 3.

Currency Falls

The economy will contract 1.2 percent this year, marking Canada’s first recession since 1992, and then grow 3.8 percent in 2010, the central bank said. Economists in a Bloomberg News survey predict just a 2 percent expansion next year.

“We just don’t see that kind of bounce-back coming,” said Benjamin Reitzes, an economist at BMO Capital Markets in Toronto, referring to the Bank of Canada’s growth figures. “Every sovereign body has also been putting out pretty bleak forecasts,” and the central bank’s predictions for global growth may be too high, he said.

Scotia Capital Economist Derek Holt and CIBC World Markets Senior Economist Avery Shenfeld also wrote in notes to clients today that the central bank’s 2010 growth forecast may be optimistic.

‘Constraining Growth’

The Canadian dollar gained 0.1 percent to C$1.2534 per U.S. dollar at 3:01 p.m. in Toronto, from C$1.2551 yesterday.

Exports will shave 2.6 percentage points off of economic growth this year, then add 2.1 percentage points in 2010, aided by a weaker currency and a rebound in U.S. demand, the bank said.

“The issue is whether Canada can do that well in 2010 if some of the structural issues facing the global economy are still constraining growth in our export markets,” said Avery Shenfeld, a senior economist at CIBC World Markets in Toronto.

Actions taken by Canada and other countries to shore up credit markets and economies “are starting to gain traction,” the central bank said.

The report repeated that the Bank of Canada will assess “to what extent further monetary stimulus will be required” to meet its chief goal of keeping inflation at 2 percent.

Inflation will decline by 0.6 percent in the second quarter and 1 percent in the third and won’t return to the bank’s target until the first half of 2011, the bank said.

Deflation Unlikely

Consumer prices haven’t dropped for two or more consecutive quarters since 1953, according to Statistics Canada.

“The possibility of deflation is remote in Canada,” Carney said at a press conference after the report was published. Most of the price decline will come from energy, instead of a widespread drop associated with deflation, Carney said. More than half of the consumer price index’s items have prices advancing faster than 2 percent now, Carney, 43, said.

Deflation can freeze spending by business and consumers if they hold off on purchases in anticipation of ever-lower prices. Reversing deflation can be harder than inflation because central banks can only cut interest rates so low to encourage demand.

Still, even during the financial crisis that has crippled access to credit in the world’s biggest economies, lending to businesses in Canada “grew at a solid pace” through November and household credit “has slowed only moderately,” the central bank said. The cost of borrowing for commercial lenders has fallen by 1 percentage point since October, the bank said, citing reductions in its own benchmark interest rate.

‘Remote Situations’

Those comments contrast with Finance Minister Jim Flaherty’s statement last year that the country’s banks, rated the soundest by the World Economic Forum, should do more to expand lending.

There was no reference in the report to whether the central bank may use policy tools other than interest-rate cuts to boost credit markets in Canada, measures that have been taken in the U.S. and Japan.

Carney told reporters he is studying such measures as part of regular planning for “highly unlikely, remote situations.” He also said he won’t “sneak up” with any extraordinary moves, and would lay out clear terms and objectives before proceeding.

To contact the reporter on this story: Greg Quinn in Ottawa at gquinn1@bloomberg.net.

Last Updated: January 22, 2009 15:04 EST