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

April 12, 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 the Bank targets for monetary policy purposes, at 1.00 percent at its next announcement on April 17, 2012. While most members in the group felt that strength in domestic demand and growing household debt warranted increases in the overnight rate over time, the MPC’s formal recommendation was for the overnight rate to remain at 1.00 through October, and rise to 1.50 percent by April 2013.

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 announcement, the announcement after that, the announcement in six months’ time, and the announcement in one year’s time. While the call for an unchanged target on April 17 was unanimous, three of the MPC’s 12 members urged a higher overnight rate at the time of the June announcement, and five wanted a higher rate by October. By April 2013, five members were calling for an overnight rate target of 1.00 percent, with the other seven looking for a target between 1.50 and 2.50 percent.

In looking at recent indicators of economic growth and inflation, the group tended to feel that the Canadian and US economies are growing at rates consistent with narrowing output gaps and stable or slightly rising inflation, with the outlook abroad being less buoyant: recession in Europe, at least through the time horizon of the MPC’s recommendations, and decelerating output in major emerging markets. This environment creates a clear tension for the Bank of Canada: Canada’s domestic circumstances warrant a move to an overnight rate more consistent with stable growth and 2 percent inflation over the long term, while concerns about weakness in external demand and the potential impact of a stronger Canadian dollar argue against a rate increase. Among members emphasizing threats from abroad, the potential for a financial crisis in Europe and/or US weakness as a result of eventual fiscal tightening figured prominently. To a considerable extent, varying judgements on the importance of these two considerations determined individual MPC members’ votes.

Some members urging a higher overnight rate over the coming year took a more optimistic view of global prospects. For the most part, however, the tendency toward a higher rate target stemmed from concern that Canada’s growth is too tilted toward housing and fuelled by rising household indebtedness. Many members, including some who called for an unchanged overnight rate over the coming year, wanted to see more aggressive use of other tools of macroprudential regulation – particularly those affecting mortgage lending – to damp the excesses. Some expressed concern that the Bank of Canada has created expectations that it will not increase its policy rate until the US Federal Reserve – which is making policy for an economy with weaker demand and more difficult financial problems than Canada’s – increases its policy rate. A majority of MPC members thought that the Bank of Canada should signal, both through its words and its actions, that a higher overnight rate and potentially a higher exchange rate as well are part of the monetary policy package that will keep Canada on a path toward stable 2 percent inflation.

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 May 31, 2012, prior to the Bank of Canada’s interest rate announcement on June 5, 2012.

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