Jan. 22 (Bloomberg) -- The Bank of Canada lowered its main interest rate a quarter point, the second reduction in as many months, and signaled it will act again to shield the economy from the threat of a recession in the U.S.

The target rate for overnight loans was cut to 4 percent as forecast, the lowest since May 2006, at a regularly scheduled meeting. Earlier today, the U.S. Federal Reserve cut its key rate three-quarters of a point to 3.5 percent in an emergency move, creating the biggest gap between U.S. and Canadian rates since 2004.

The Bank of Canada may make deeper rate cuts this year because the U.S. reduction signals a worsening slowdown in that country, which is Canada's biggest export market, economists said. Still, they said, policy makers won't make surprise cuts before their next meeting on March 4 because a commodities boom and wage gains continue to prop up Canadian consumer spending.

``The Bank of Canada's history is it tends to follow the Fed with a lag,'' said Ted Carmichael, chief Canadian economist at J.P. Morgan Securities in Toronto. ``That's going to be the pattern again this time.''

Stewart Hall, a market strategist at HSBC Securities Inc. in Toronto, said the Fed's action today will help Canada by increasing demand in the U.S.

``The implication is that it ameliorates the negative impact of U.S. economic weakness, which seems to be one of the major themes driving Bank of Canada policy,'' he said.

Currency, Stocks Rally

Canada's dollar strengthened 1.3 percent to C$1.0221 per U.S. dollar at 1:55 p.m. in Toronto, from C$1.0349 yesterday. Canadian stocks rallied, posting the biggest gain since October 2002 after the worst loss in seven years yesterday. The Standard & Poor's/TSX Composite Index gained 382.69, or 3.2 percent, to 12,514.82.

All 22 economists in a Bloomberg survey predicted the Canadian decision.

The moves today may help preserve the longest economic expansion since World War II even as growth in the U.S. slows. Canadian exports such as lumber and cars make up 30 percent of economic output, and about 80 percent of those sales are to the U.S. The rate cut also comes with less risk of quicker inflation, because the strong Canadian currency has made imported goods cheaper.

In the statement accompanying their decision, policy makers hinted more cuts may be required ``in the near term.''

`Door Wide Open'

Carmichael said he predicts the bank will lower borrowing costs by a half point at meetings in March and April, and another quarter point on June 10. Doug Porter, deputy chief economist with BMO Capital Markets in Toronto, said policy makers will probably cut the rate to 3 percent by mid-year.

``They have left the door wide open for more aggressive moves down the road,'' Porter said in an interview, adding that a move before March 4 is ``unlikely.''

Porter had predicted earlier that rates would fall to 3.75 percent by April. Eric Lascelles, chief economics and rates strategist at TD Securities in Toronto, revised his forecast for March today to a half-point cut from a quarter-point reduction, and predicted a quarter-point cut in April.

The decision is the last for Bank of Canada Governor David Dodge, 64, who is retiring at the end of the month. Mark Carney, a 42-year-old former Goldman Sachs Group Inc. investment banker, takes over on Feb. 1. The central bank's policy makers lowered the rate for the first time in more than three years on Dec. 4.

`Very Fluid Times'

The bank may still opt for a surprise cut before the next meeting because the economy and financial markets are in ``very fluid times,'' said Craig Wright, chief economist at Royal Bank of Canada, the country's biggest lender by assets. Canada's export slowdown ``is going to get even bigger,'' he said.

In the U.S., where household purchases and home construction have stalled, President George W. Bush last week proposed a $150 billion stimulus plan to help keep the world's largest economy from contracting. Two of Canada's five biggest exports are cars and building materials, which rely on U.S. consumer spending.

Canada's currency reached an all-time high 90.58 Canadian cents per U.S. dollar on Nov. 7. The currency's 14 percent advance over the past year is slowing exports, by making them more expensive in the U.S., and already has pushed the central bank's preferred inflation measure below its 2 percent target.

Forecasts

The central bank today cut its forecast for the consumer price index because of the higher dollar and a 1 percentage point cut in the federal sales tax this year. Inflation will slow to less than 1.5 percent by midyear, the bank said, compared with an October projection that it would accelerate by an average of 1.9 percent in the second half.

Inflation excluding eight volatile items such as seasonal fresh fruit slipped to a 1.6 percent year-over-year pace in November from 2.5 percent in June, as the higher value of the dollar increased Canadians' purchasing power. The central bank uses that ``core'' inflation rate as a guide to future trends.

Policy makers also said they now predict weaker economic growth for this year than they anticipated in an October forecast. They didn't provide a new projection, saying they'll release an economic forecast in two days.

``The effects of the weaker U.S. economic growth outlook will lead to additional downward pressure on export growth,'' the central bank said in a statement today. ``Further monetary stimulus is likely to be required in the near term.''

Economists polled by Bloomberg say growth this year on an annualized basis will slow to 2.1 percent from 2.6 percent in 2007. In October, the central bank said growth this year would be 2.3 percent.

Domestic spending is expected ``to remain strong,'' the central bank said today, mostly because companies and workers in some parts of the country are still benefiting from higher prices for Canadian commodities such as oil, metals and farm products.

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

Last Updated: January 22, 2008 14:01 EST