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Canada's days of bucking the U.S. economic downturn have come to an end, according to a forecast to be released today.

A projection for the Canadian economy by Toronto-Dominion Bank is expected to show that Canada's slowdown is happening at the same time and to the same extent as the downturn in the United States. It also projects that Canada will likely register a quarterly contraction before the U.S.

The first quarter of 2008 will probably be slightly negative for Canada, followed by an ever-so-slightly positive second quarter, said Don Drummond, chief economist for TD. “That's as damn close as you can come” to a recession without actually having one, he said.

The United States will likely see a flat first quarter, a slightly negative second quarter, followed by a stronger third quarter boosted by the fiscal stimulus package that will begin to take effect, he said.

Over all, both economies are projected to grow by a near-stagnant 1.1 per cent in 2008.

The TD forecast is the second major projection to show Canada and the United States on the same feeble growth path. Last week, University of Toronto economists showed both countries with no growth at all in the first quarter, and small contractions in the second quarter of 2008.

Still, the reaction of economic policy makers could not be more different.

In the United States, even as inflationary pressure rises, the U.S. Federal Reserve has moved fast and furiously to stave off recession and contain the financial fallout from the subprime mortgage crisis.

In Canada, inflation is benign, leaving plenty of room for the central bank to cut rates with impunity. Total inflation in February was 1.8 per cent higher than a year ago, down from the 2.2 per cent pace for January, according to Statistics Canada numbers released yesterday.

But instead of cutting, the Bank of Canada is taking its time, letting the gap between Canadian and U.S. key interest rates grow bigger and bigger. The Canadian central bank has cut its key rate by 100 basis points since the global credit crunch boiled over in August, while the Fed has cut by 300 points.

The spread between the two rates now stands at 125 basis points (a basis point is 1/100th of a percentage point), the widest in four years.

“It does seem perverse, in a sense,” Mr. Drummond said.

There are good reasons why the Fed is hyperventilating while the Bank of Canada is taking deep breaths, economists said. The United States is also trying to contain a financial market meltdown, compounded by the bailout of investment bank Bear Stearns.

Plus, the source of most of Canada's economic woes is the weakness in the United States – something Canadian policy makers can't fix directly.

The U.S. slowdown has hit hardest in the U.S. auto sector, housing and capital markets.

“You can't imagine a worse combination for the Canadian economy,” Mr. Drummond said.

At the same time, strong consumer demand in Canada is fuelling auto sales, housing starts and home prices. Those areas would be the first to benefit from Canadian interest rate cuts, but they are the same areas that need such cuts the least.

The Bank of Canada can't sit on its heels. The widening gap between the two countries' interest rates threatens to drive up the Canadian dollar at a time when Canadian exporters can least afford it, said Ted Mallett, head of research for the Canadian Federation of Independent Business.

“I wouldn't want to see [the spread] grow any larger, and I wouldn't want it to stay this large for much longer,” he said.

For now, the Canadian dollar is stuck in a trading range around parity, pushed and pulled by commodity prices, the falling U.S. dollar, interest rate spreads and economic fundamentals, economists said.

That means for the time being, Canada can handle having its key interest rate significantly higher than in the United States, explained Avery Shenfeld, economist at CIBC World Markets.

“We can handle it temporarily … as long as the Bank of Canada keeps talking about rate cuts to come,” he said.