C.D. Howe Institute’s Monetary Policy Council Calls for Bank of Canada to Raise its Benchmark Interest Rate Target to 3.25 Percent

Toronto, July 10 — The C.D. Howe Institute’s Monetary Policy Council (MPC) today recommended that the Bank of Canada raise its target for the key overnight interest rate to 3.25 percent at its next announcement on July 15. 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. Four of the nine members attending the meeting recommended keeping the target rate at 3.00 percent and five recommended raising the rate – with four of those five urging a target of 3.25 percent, and one urging a target of 3.50 percent.

Notwithstanding the division in opinion regarding the Bank of Canada’s July 15 decision, the main theme of the group’s discussion was concern about rising inflation and rising inflation expectations. Persistently high oil prices, the likelihood that the year-over-year increase in the consumer price index (CPI) will move above the top of the Bank’s 1-to-3 percent target range, evidence of higher inflation expectations in the Bank’s recent Business Outlook Survey, and increases in wages well above inflation all featured prominently in the discussion. Several members argued that the Bank of Canada should act aggressively to prevent expectations of higher inflation becoming more pronounced and affecting price and wage setting.

Members favouring a less aggressive response by the Bank tended to emphasize that domestic demand growth is faltering, that credit and financial conditions are less robust now than was anticipated in the spring, and that the pressure of higher energy and food prices on the year-over-year CPI measure will be temporary. In only one case, however, did concern about financial and economic weakness, and confidence that inflation will be contained, lead to a call for an overnight rate target below 3.25 percent in 6-to-12 months’ time. Most members favouring no or moderate increases in the overnight rate in the near term urged the Bank to communicate strongly its determination to act more vigorously if inflation and inflation expectations turned out to be worse than expected.

The discussion featured several key points of uncertainty. The state of credit and financial markets was one, with several members pointing out that Canada is weathering a difficult global episode relatively well. The steadiness of the Canadian-US dollar exchange rate in the face of higher oil prices was another, with members differing about the degree to which further exchange-rate appreciation might insulate Canadians from expensive energy. And critically, the group debated Canada’s potential growth rate, with members favouring a more aggressive monetary stance emphasizing that weak productivity and stalled growth in aggregate supply might limit the extent to which weak demand would open up a disinflationary output gap.

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 July 15, 2008 setting and the September 3, 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 August 28, 2008, prior to the Bank of Canada’s interest rate announcement on September 3, 2008.

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