open up this year would have closed by the end of 2004. we projected that core inflation would likely fall to about 2 1 / 2 per cent in the second half of this year and to about 2 per cent by early 2004 as some of the special factors pushing up inflation ran their course. we also pointed out that total cpi inflation would continue to be importantly affected by swings in crude oil prices and that it would likely fall temporarily below the core rate in the first half of 2004 before steadying out at a rate close to core inflation. factors influencing monetary policy in the april monetary policy report, we listed a number of factors that we intended to watch closely as we set monetary policy. these factors are the pace of economic expansion in the united states and overseas, the strength of domestic demand, financial market conditions, and the evolution of inflation and inflation expectations. so, let me review how we have seen these factors evolving. i ’ ll start with the external environment. in europe, domestic demand and economic growth have continued to disappoint. japan ’ s economy has also remained weak. while demand growth in the rest of asia has been strong, the outbreak of severe acute respiratory syndrome ( sars ) is clearly going to slow growth in some countries. in the united states, domestic demand has not been recovering as quickly as expected, which has negative implications for canadian exports, at least over the short term. consumer spending continues to underpin economic activity in that country. however, business fixed investment has not yet picked up. expectations as to when the u. s. recovery will occur have been pushed back until late this year when confidence levels should improve, and when the impact of very expansionary monetary and fiscal policies should begin to be fully felt. now, let ’ s turn to the second factor - domestic demand in canada. on the whole, demand has remained quite strong, supported by a healthy employment market, low interest rates, and a recovery in corporate profits. while growth in consumer spending slowed slightly in the first quarter, it was still quite strong, especially on housing. governments and businesses both increased their spending. as a result of strong domestic demand, gross domestic product grew at an annual rate of almost 2 1 / 2 per cent in the first quarter, up from about 1 1 / 2 per cent in the final quarter of 2002. in nova scotia, we are seeing some fall - off in consumer spending. business investment prospects have also been dampened by the postponement of natural gas projects

the economy. by the spring of 2002, evidence had already started to build that demand was recovering more quickly than had been anticipated. so, even though demand pressures were not yet showing up in prices, we began to remove some of that monetary stimulus. we raised our key policy interest rate three times between april and july 2002, by a total of three - quarters of a percentage point. by last autumn, inflation in canada was on the rise. but we refrained from raising interest rates any further at the time, because we judged that the pickup in inflation was mainly the result of one - off factors and would be reversed over the next year or so. as well, there was considerable geopolitical and financial uncertainty, which, combined with global economic weakness, pointed to restrained total demand for canadian goods and services. through the first quarter of this year, cpi inflation climbed well above the 2 per cent target. much of the rise was the result of higher energy prices. we also saw a marked increase in our measure of core inflation, which strips out the eight most volatile items - including gasoline, heating oil, and natural gas - from the cpi basket, as well as the effect of changes in indirect taxes on the remaining cpi components. the rise in core inflation was exacerbated by further increases in automobile insurance premiums. but even allowing for the unusual and extraordinarily large increases in insurance premiums, inflation was well above target. this suggested that strong domestic demand was putting pressure on production capacity. in this environment, some indicators of short - term inflation expectations edged up, although longer - term expectations remained around 2 per cent. in view of these inflation developments, the momentum of domestic demand, the narrowing of interest rate spreads in credit markets, and diminishing geopolitical uncertainty, we raised our target overnight rate by 25 basis points in march and again in mid - april - bringing it to 3. 25 per cent. in our april monetary policy report, we stated that the risks confronting the world economy appeared to be more evenly balanced than they had been in the autumn. the canadian economy was projected to strengthen appreciably towards the end of 2003 and to grow somewhat above its production potential during 2004, thanks to a pickup in economic activity in the united states and further improvements in business and consumer confidence. we concluded in april that although growth would likely remain somewhat below potential in canada for the first three quarters of this year, most of the small amount of economic slack that would