C.D. Howe Institute’s Monetary Policy Council Calls for Bank of Canada to Keep its Benchmark Interest Rate Target at 3.00 Percent

Toronto, August 28 — The C.D. Howe Institute’s Monetary Policy Council (MPC) today recommended that the Bank of Canada maintain its target for the key overnight interest rate at 3.00 percent at its next announcement on September 3, 2008. The overnight rate is a very short-term money-market rate that the central bank targets for monetary policy purposes.

The MPC is a panel sponsored by the C.D. Howe Institute to provide an independent assessment of the monetary stance most appropriate for the Bank of Canada as it seeks to achieve its 2 percent inflation target. William Robson, the Institute’s President and CEO, chairs the Council.

The MPC’s formal recommendation is its median vote. Seven of the 11 members attending the meeting recommended keeping the target rate at 3.00 percent, while four recommended raising the rate to 3.25 percent.

The Council’s decision to recommend an unchanged overnight rate reflected a balance between two contrasting sets of considerations. Several members stressed indicators of weaker demand and softening growth prospects in Canada and abroad, and the likelihood that easing price pressures will bring inflation back toward the Bank’s 2 percent target. Others stressed continued pressures on productive capacity and expectations of higher inflation, and argued that monetary policy has been, and risks continuing to be, too accommodative to hit the inflation target. As the Council looked further ahead, these latter considerations tended to get more weight: while it recommended continued maintenance of the overnight rate at 3.00 percent at the Bank’s October announcement, the median call for the overnight rate in six-to-twelve months’ time was 3.25 percent.

For the group that argued for unchanged or lower overnight rates in the short and medium term, weakening real output in Canada and overseas was a central concern. These members also tended to emphasize the retreat of commodity prices, and the likelihood that inflation, inflation expectations and labour costs in Canada will come into line with the Bank’s target.

The group that favoured a more aggressive stance by the Bank tended to see slower growth as a necessary step toward lower inflation. These members were concerned by the fact that the year-over-year increase in the total CPI has been so consistently above the Bank’s target since early 2007, is currently above 3 percent, and has been recently forecast by the Bank to stay well above target through early 2009.

For some members, uncertainty about continued stresses in credit markets suggested continued caution, since the gap between the overnight rate and consumer and other borrowing costs continues to be large and potentially volatile. The group also debated the state of inflationary expectations in Canada and abroad, with the sensitivity of these measures to recent experience, especially the prices of oil and gasoline, being a point of uncertainty. The extent to which recent slow growth in Canada reflects sluggish growth of the economy’s productive capacity also puzzled the group, with differing labour-market indicators pointing to different conclusions on this point.

Most critically, the group differed on the position in which past monetary easing has left the Bank of Canada. More dovish members felt that softening demand and easing inflation merited an unchanged or lower overnight rate in the months ahead, while more hawkish members felt that the Bank had been too accommodative, and needed to give priority to bringing inflation down.

The recommendation of the MPC is the median of the votes cast by individual members attending the session. The table shows the median votes and individual recommendations for the overnight rate at the September 3, 2008 setting and the October 21, 2008 setting, as well as the group’s views about the target in 6-to-12 months’ time.

The views and opinions expressed by the Council’s members are their own and do not necessarily reflect the views of the organizations with which they are affiliated, or those of the C.D. Howe Institute.

The MPC’s next vote will take place on October 16, 2008, prior to the Bank of Canada’s interest rate announcement on October 21, 2008.

* * * * *

Contact: Kristine Gray — phone: 416-865-1904; e-mail: kgray@cdhowe.org.