Predicting subdued global growth, and refusing to measure the impact of SARS, the Bank of Canada cut its gross domestic product targets for 2003 and warned further interest rate hikes may follow.

In its report, the central bank made a brief reference to the spread of severe acute respiratory syndrome (SARS), conceding that it had "also increased uncertainty."

"Obviously anything of this magnitude does have an effect, but it's just impossible at this time to make an assessment of the magnitude of its economic effect," Bank of Canada Governor David Dodge told reporters in Ottawa.

"There will be an impact during the second quarter, but at this point we cannot estimate an exact figure for this impact."

The bank cut its growth outlook for Canada to 2.5 per cent this year. That's down from the January forecast of nearly three per cent. But the governor would offer no specific estimate of the economic impact of the disease.

"Obviously the impact will come most importantly, and certainly first, in the areas related to the hospitality, tourism and travel industry," Dodge told reporters. "The Greater Toronto area accounts for a fifth of the total economic activity in Canada."

In Ottawa Wednesday afternoon, Finance Minister John Manley echoed the Dodge's comments.

"It's really too early to evaluate the impact of SARS on economic growth for the year," Manley told reporters.

"But I think we're seeing a slower rate of growth than was forecast. We're seeing continuing softeness in the U.S. economy. One is hopeful that as some of the uncertainties decline that we'll be able to see a pick up in growth later in the year."

The bank's average growth projections for the first three quarters of 2003 did not account for the impact of SARS, but did incorporate the view that the global economy has expanded more slowly than predicted in January. With the war in Iraq apparently nearing an end, oil prices dipping lower and financial conditions improving, "the risks confronting the world economy are now better balanced."

While the bank cut growth forecasts, it also estimated that expansion could outpace the economy's three per cent growth potential over the course of 2004. According to the report, the bank's "conventional measure of potential suggests that the economy is still operating very close to its full production capacity."

The bank also predicts inflation could fall below four per cent by mid-year. Depending on the price of oil, inflation could fall to 3.75 per cent in the second quarter.

Excluding energy prices, core inflation could drop to two per cent by early 2004.

But the bank hinted that change may not come without another hike in interest rates.

"Given the underlying momentum of domestic demand, and an expectation that external demand for Canadian products will strengthen as uncertainties recede and confidence improves, the bank continues to believe that further reductions in monetary stimulus will be necessary over time to return inflation to its 2 percent target and to sustain output levels close to capacity," the bank said in its semi-annual Monetary Policy Report.

In contrast with the U.S. Federal Reserve, Canada's central bank has recently raised interest rates several times. At 3.25 percent, Canada's overnight interest rate stands a full 2 percentage points above comparable U.S. rates.

According to Dodge, the timing of further increases in interest rates policy will depend on the strength of domestic demand, evolving inflation expectations and the pace of economic expansion in the U.S. and overseas.