(Bloomberg) — The Bank of Canada reduced its benchmark interest rate for a second time this year as the damage from lower oil prices shrank the economy in the first half and leaves a full recovery almost two years away.

Gross domestic product probably “contracted modestly” in the first half, policy makers said, without calling it a recession, which is typically defined as two straight quarters of negative growth. Output will recover this quarter as non- energy exports rebound from a decline the bank called “puzzling.’

The central bank lowered the benchmark rate on overnight loans between commercial banks to 0.5 percent from 0.75 percent, where it had been since a cut in January. The first-half contraction led to a “marked increase in excess capacity,” the bank said.

“The lower outlook for Canadian growth has increased the downside risks to inflation,” policy makers led by Governor Stephen Poloz said in a statement Wednesday. “While vulnerabilities associated with household imbalances remain elevated and could edge higher, Canada’s economy is undergoing a significant and complex adjustment.” Poloz is scheduled to hold press conference at 11:15 a.m.

Policy makers at the Ottawa-based bank said output probably shrank at a 0.5 percent annualized pace in the second quarter, compared with an April prediction of a 1.8 percent expansion. The economy registered a 0.6 percent contraction between January and March.

Historically low interest rates have already pushed consumer debt-loads and home prices to record highs, while failing to trigger lasting investment and export gains.

Fifteen of 29 economists in a Bloomberg News survey predicted the reduction, with the rest calling for no change.

The economy won’t return to its full capacity to keep inflation at 2 percent “on a sustained basis” until the first half of 2017, the bank said Wednesday, later than the April forecast of around the end of 2016. The “underlying trend” of inflation is between 1.5 percent and 1.7 percent the bank said, down from the prior estimate of 1.6 percent to 1.8 percent.

Oil and gas investment will drop by almost 40 percent this year, even with benchmark crude prices up by about $10 to $15 a barrel from April, the bank said. Crude oil is Canada’s top export and lower prices are prompting producers from Suncor Energy Inc. to Imperial Oil Ltd. to accelerate a shift to smaller projects.

“The mood has been really challenging over the last four to six weeks,” Greg Stringham, vice president of markets and oil sands at the Canadian Association of Petroleum Producers in Calgary, said by telephone before the decision. “The recent downturn really just has added to the concern this is going to be longer-lasting.”

The Bank of Canada cut its 2015 growth forecast to 1.1 percent from 1.9 percent, and cut the contribution from exports to 0.6 percentage points from 1.4 points. It also cut next year’s growth forecast to 2.3 percent, from 2.5 percent.

Poloz foresaw some of the weakness in January when he became the first Group of Seven banker to cut rates in response to the oil shock, equating the reduction to an “insurance policy” against the damage. He later said the move would probably be sufficient because a weak currency and U.S. demand would boost exports of non-energy products.

Instead, falling mineral and metal shipments led to a fifth straight export decline in May, making the cumulative year-to- date trade deficit the largest on record. The central bank said Wednesday it still expects a rebound in non-energy exports to help lead a recovery.

“The non-resource track for growth will begin to dominate in the third quarter,” policy makers said, predicting the economy will expand by about 1.5 percent in that period.

For the housing market, where the cheapest mortgages in decades have led to record consumer debt burdens, the bank reiterated its view there’s no bubble. “The Bank continues to anticipate a constructive evolution in the housing market,” its economic forecast paper said, with a moderation in housing in 2015, followed by stabilization in 2016 and 2017.

–With assistance from Erik Hertzberg in Ottawa.

 

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