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The Bank of Canada slashed its key interest rate to the lowest since the institution was founded in 1934 and signaled that more cuts may be needed to jolt the economy out of recession and stabilize credit markets.

Governor Mark Carney cut the target rate on overnight loans between commercial banks by half a point to 1 percent, lower than the previous record of 1.12 percent in 1958 when the rate was based on treasury-bill yields. The move was anticipated by 19 of 20 economists surveyed by Bloomberg News.

Canada’s move mimics efforts in the U.S., the U.K. and Japan to revive lending as credit markets reel from about $1 trillion of write-offs and losses. The collapse of financial firms such as Lehman Brothers Holdings Inc. and Fortis contributed to the worst global downturn since the Great Depression and helped push Canada into a recession for the first time since 1992.

“The Bank will continue to monitor carefully economic and financial developments in judging to what extent further monetary stimulus will be required,” policy makers said in a statement today from Ottawa, repeating a phrase they used to announce a reduction last month.

The economy will shrink through the middle of 2009 for an annual decline of 1.2 percent, the central bank said, scrapping an October prediction for an expansion of 0.6 percent. Canada’s inflation rate will be negative for two quarters this year due to lower energy prices, and policy makers said it won’t return to their 2 percent target until the first half of 2011.

‘Still Open’

“The door is still open for more cuts,” said Martin Lefebvre, a senior economist at Montreal’s Desjardins Group, Quebec’s largest credit union. “There’s no doubt in my mind they will cut again in March. The economic context is deteriorating.”

The Canadian dollar dropped 0.6 percent to C$1.2610 per U.S. dollar at 10:22 a.m. in Toronto, from C$1.2538 yesterday.

The country’s exports and domestic demand are falling and “it will take some time for financial conditions to normalize,” worldwide, the central bank said. Still, the bank said there are signs that “extraordinary measures” taken by policy makers worldwide are “starting to gain traction” and help markets.

The financial crisis has driven up banks’ borrowing costs and forced them to raise new capital. That in turn has made them reluctant to extend credit to consumers and businesses.

‘Credit-Worthy’

Bank of Canada officials and Finance Minister Jim Flaherty have said the country’s banks, rated the soundest last year by the World Economic Forum, have scope to expand lending.

Executives from the country’s biggest banks told Carney, 43, and Flaherty, 59, at a meeting this month that they continue to lend to “credit-worthy” clients.

Five banks including Royal Bank of Canada, Bank of Montreal and Toronto-Dominion Bank matched the Bank of Canada’s interest-rate cut today, after they and the rest of the biggest lenders failed to immediately match the full 75-basis point reduction in December low fee payday advance. The lenders today cut their prime rates to 3 percent from 3.5 percent.

Policy makers in Canada may be closer to trying a strategy known as quantitative easing, Carlos Leitao, chief economist at Laurentian Bank Securities in Montreal, said before the decision. That policy is designed to leave banks with so much free cash that they stop hoarding and expand lending. It can involve a central bank buying securities and creating money to pay for them.

Global Moves

The U.S. Federal Reserve cut its main interest rate to as low as zero on Dec. 16 and pledged to buy unlimited quantities of securities, after a series of policy moves failed to arrest what may be the worst recession since World War II. The Bank of England on Jan. 8 cut its main rate to 1.5 percent, the lowest since its founding in 1694, and last week the European Central Bank cut its benchmark rate to the lowest recorded level.

Canada’s economy is suffering from sluggish exports of goods such as lumber and cars and low prices for commodities such as oil and metals, causing a net job loss of 105,000 in November and December and a decrease in domestic demand.

Canadian factory owners posted the biggest monthly sales drop on record in November, with shipments abroad falling 6.4 percent, Statistics Canada reported earlier today from Ottawa. New orders dropped 13 percent that month, the agency said.

Fiscal Plan

The Bank of Canada’s stimulus may be followed next week by the biggest fiscal boost in decades.

Flaherty said Jan. 9 that his Jan. 27 budget will include a “substantial” deficit, Canada’s first in 12 years. The plan will generate a shortfall of between C$20 billion ($16 billion) and C$30 billion in the coming fiscal year, Prime Minister Stephen Harper said in an interview last month with CTV.

The central bank will update its forecasts for economic growth and inflation on Jan. 22. Today’s statement predicted that output would rebound in 2010, expanding by 3.8 percent.

Business executives in Canada say they’re struggling with the tightest credit climate since at least 2001, according to a central bank survey released Jan. 12.

Rate cuts may not boost spending right away because companies are too worried about the economic outlook to spend even if they have access to credit, Doug Munro, 46, president of Maritime-Ontario Freight Lines Limited, said Jan. 15 in an interview from Brampton, Ontario.

While Munro’s company has held on because it ships products such as foods that are in steady demand, the recession has him re-thinking plans to buy more containers and undertake a C$4 million, 15-acre expansion of his truck depot.

“My instinct is, with all of this trouble in the economy, maybe it would be better to wait,” he said.

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