C.D. Howe Institute’s Monetary Policy Council Calls for Bank of Canada to Maintain Overnight Rate at 0.25 Percent, With Increase to 2.00 Percent in January 2011

Toronto, January 14 — The C.D. Howe Institute’s Monetary Policy Council (MPC) today recommended that the Bank of Canada hold its target for the overnight interest rate at 0.25 percent at its next announcement on January 19, 2010. (The overnight rate is a very short-term money-market rate that the central bank targets for monetary policy purposes.) The Council further recommended that the Bank keep the target at 0.25 percent at the next announcement in March, in keeping with the Bank’s conditional commitment to do so until mid-year. The MPC’s recommendation for July, the first announcement date after the Bank’s conditional commitment expires, was for a target of 0.75 percent. Looking one year ahead, the Council’s recommendation was for a target of 2.00 percent in January 2011.

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. All 10 members attending the meeting recommended a target of 0.25 percent at the next setting, and nine recommended the same for March. For the July setting, five members urged a target of 0.75 percent, three urged 0.50 percent, one 1.00 percent and one 1.50 percent. Calls for the rate in January 2011 ranged from a low of 1.25 percent to a high of 2.75 percent.

The group generally agreed about the outlook for output and inflation, expecting growth to continue at modest rates through 2010 and 2011 and inflation to return – accelerated as last year’s low figures drop out of the year-over-year rate – to the 2 percent target. Members noted that demand in the United States and overseas will likely remain subdued as private and public-sector balance sheets are rebuilt, and many felt that contrasts in economic growth rates and, potentially, in perceptions of credit risk in Canada versus those abroad are likely to keep the Canadian dollar on an appreciating path.

The challenge facing the Bank of Canada as it transitions from its conditional commitment to keep the overnight rate at its effective minimum until mid-year inspired debate on three fronts: about the appropriate level of the overnight rate in the long term; about the best path for getting there; and about the influence of other policy actions currently affecting monetary conditions.

Some members who looked for relatively modest increases in the overnight rate in a year’s time thought that subdued demand would keep the general level of interest rates world-wide, at least for good credit risks, low for a protracted period, in which case smaller increases in the policy interest rate – perhaps complimented by an appreciating exchange rate – would be required to keep inflation in check. This group tended to emphasize the likelihood that unwinding central bank and government supports for credit markets, and fiscal restraint more generally, would damp growth.

Members who looked for larger increases tended to emphasize that the long-term level of the overnight rate is likely to be closer to historical norms. They were less inclined than their colleagues to think that the withdrawal of quantitative measures and credit supports would slow the economy. And they were more inclined to think that the Bank of Canada should move the overnight rate up in larger increments than financial market participants expect.

On the need, and best way, for the Bank of Canada to signal that its commitment to keep the overnight rate at 25 basis points is conditional, and that interest rates will need to move higher before long, the group had mixed views. Some members felt that the Bank should be very cautious in its communications, given continued nervousness about the economy and the potential for misunderstandings about the Bank’s intentions in such sensitive areas as the exchange rate and the housing market. Others felt that the Bank needed to be clearer about its expectations after mid-year. Two members thought that marginal increases, say 5 basis points, in policy interest rates – in one case, in the overnight rate itself, and in another case, in the minimum bid for the Bank’s Term Purchase and Resale Agreements – would provide useful signals about the upward path of rates after the current conditional commitment expires. Others in this camp urged more forthright discussion about the Bank’s expectations for the overnight rate, conditional on future developments in the economy and inflation, in upcoming communications.

The table shows the median votes and individual recommendations for the overnight rate at the January 19, 2010 setting and the March 2, 2010 setting, as well as the group’s views about the target in 6 and 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 February 25, 2010, prior to the Bank of Canada’s interest rate announcement on March 2, 2010.

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