C.D. Howe Institute’s Monetary Policy Council Urges Bank of Canada to Hold Overnight Rate at 1.00 Percent

August 30, 2012 — The C.D. Howe Institute’s Monetary Policy Council (MPC) today recommended that the Bank of Canada maintain its target for the overnight rate, the very short-term interest rate it targets for monetary policy purposes, at 1.00 percent at its next announcement on September 5, 2012. The Council further recommended that the Bank hold the overnight rate target at 1.00 through March of 2013, and called for a target of 1.25 percent by August of next year.

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 makes formal recommendations ­­– its median vote – for the Bank of Canada’s upcoming rate announcement, the subsequent announcement, the announcement in six months’ time, and the announcement in one year’s time. Eleven of the members attending the meeting called for a 1.00 percent target at the upcoming setting and one called for .75 percent target.  Ten members supported a 1.00 percent target and two a .75 percent target at the next setting in October.  Looking ahead to August 2013, the median vote was 1.25 percent, although only one of the members supported that exact target. (When the MPC’s median vote falls between two numbers, as with the August 2013 vote, the result is rounded in the direction of the mean vote.) The full range of views for the overnight rate a year from now ran from a low of 0.75 percent to a high of 2.25 percent.

The major theme in the Council’s evaluation of the global growth outlook was the contrast between more encouraging recent indicators in the United States and slowness or outright decline in major economies overseas. Many members felt that, on balance, softer demand abroad and consequent declines in prices for most industrial commodities made the external environment less supportive for Canadian growth than it had been six weeks ago.

The view with regard to Canadian domestic demand was also mixed. Some members emphasized that specific factors that hurt growth in the second quarter would likely reverse in the third quarter. Others noted decelerating household credit and signs that consumer spending is weakening, and argued that while the disinflationary output gap in Canada is not very large, it is also not likely to disappear for a couple of years.

In the MPC’s discussion of uncertainties affecting their recommendations, US and European policy challenges dominated. The US “fiscal cliff” at the beginning of 2013 is clearly affecting confidence and spending in the US private sector. Some MPC members felt, however, that it created less uncertainty for Canadian policymakers than its potential magnitude suggests because the eventual policy package will probably create a larger or smaller negative shock depending on the performance of the US economy at the time it is crafted. The Eurozone’s fiscal and monetary distress loomed larger. The downside risks are larger — clearly weighing on business sentiment globally – and the policy solutions are economically and politically more challenging. Differing assessments of the likelihood and timing of a European crisis explain a large part of the divergence between the MPC members urging a lower versus a higher overnight rate target over the next year, and caused several to emphasize the need for the Bank of Canada to be ready to execute, and explain, potential sudden changes of policy stance.

The views and opinions expressed by the participants 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 18, 2012, prior to the Bank of Canada’s interest rate announcement on October 23, 2012.

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