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

October 18, 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 October 23, 2012. The Council further recommended that the Bank hold the overnight rate target at 1.00 through April of 2013, and called for a target of 1.50 percent by October 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. Nine of the members attending the meeting called for a 1.00 percent target at the upcoming setting and one called for 0.75 percent target, and the calls for the next announcement in December were the same. By April 2013, four members had raised their recommendations to the 1.25-to-1.50 range, and by October 2013, the recommendations ranged from 1.00 to 2.00 percent.

The tone in the Council’s discussion of the outlook for global and domestic growth was guardedly positive, with some of the principal threats that had preoccupied the group at its last meeting in August now looming less large. Among the positive elements noted by members were indicators of strengthening demand in the United States, attenuation of concerns about a “hard landing” in China, and the Eurozone’s avoidance of several potential triggers for a financial crisis. In Canada, notwithstanding some negative indicators of sentiment, most members expected continued moderate growth of demand, supported by continued healthy prices for commodity exports.

The group spent much of the meeting discussing potential output in the United States and especially in Canada, and the question of whether the financial crisis and slump revealed potential to be lower than previously assumed, and whether the crisis and slump had lowered potential by making large amounts of physical and human capital obsolete. Many felt that potential is considerably lower now than extrapolation of pre-crisis trends would indicate.  However, moderation in many measures of prices and costs – most notably year-over-year increases in the consumer price index far below 2 percent – and falling inflation expectations led the group to conclude that there is still a disinflationary output gap in Canada, which most felt would not disappear for some time to come.

US and European policy challenges figured prominently in the MPC’s deliberations. The US “fiscal cliff” clouds the outlook: while forecasters are calling for a noticeable but manageable hit to US demand, there is considerable uncertainty on that score. The threat of a crisis in, or even breakup of, the Eurozone is a major concern, which led some members to recommend a lower overnight rate than they would otherwise have done. Finally, several members emphasized that the US Federal Reserve’s recent commitment to keep US interest rates lower for longer changed the environment for Canada, with most feeling that low actual and expected interest rates in the United States made it harder for the Bank of Canada to raise rates, given the problems that would arise from further appreciation of the Canadian dollar. Because Canadian inflation remains below target and inflation expectations have come down, these considerations led the group to recommend slower and more moderate increases in the overnight rate than they had in August.

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 November 29, 2012, prior to the Bank of Canada’s interest rate announcement on December 4, 2012.

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