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

November 29, 2012 — The C.D. Howe Institute’s Monetary Policy Council (MPC) today called on the Bank of Canada to 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 December 4, 2012. The Council further recommended that the Bank hold the overnight rate target at 1.00 through December of 2013.

The MPC is a C.D. Howe Institute project that provides 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 recommendations ­­are the median votes of members attending the meeting. Members give their individual recommendations for the Bank of Canada’s upcoming rate announcement, the subsequent announcement, the announcement six months ahead, and the announcement one year ahead. On this occasion, nine of the ten members in attendance called for a 1.00 percent target at the upcoming setting and one called for a 0.75 percent target. The calls for the subsequent announcement in January 2013 were the same. As the group looked further ahead, recommendations diverged. The recommendations for June 2013 ran from one call for 0.50 percent, through one for 0.75 percent and seven for 1.00 percent, to one for 1.25 percent. The recommendations for December 2013 were: one call for 0.50 percent, five for 1.00 percent, and four for 1.50 percent.

Looking abroad, MPC members saw little prospect of a spur to Canadian growth from foreign demand: while several members pointed to signs that China and the United States might grow faster in the near term than some forecasters had feared, the general sentiment was that fiscal tightening and public-debt-related uncertainties in the United States would produce a weak first half of 2013, and that the Eurozone and Japanese economies would continue to shrink. Looking at Canadian domestic demand, members noted signs of cooling in the housing market, the damping effects of global uncertainty on business investment, and the tendency for foreign saving seeking a safe haven to drive the Canadian dollar up to the disadvantage of producers of tradeable goods and services.

The median call for an unchanged overnight rate over the next 12 months reflected a strong degree of consensus among the group that Canada has a disinflationary output gap that – given this configuration of foreign and domestic demand – will take at least a year to close. Given the softness of inflation and inflation expectations relative to the Bank of Canada’s 2 percent target, many members saw no reason to raise the overnight rate, and the view of some members that the rate should rise toward a less stimulative level was offset by the expectation of others that problems abroad will oblige the Bank to hold it steady or even lower it.

A major point of discussion during the meeting was the level of the overnight rate that would be consistent with stable inflation once the output gap has closed. The predominant sentiment was that the current neutral overnight rate is considerably lower than the historically neutral rate. One force keeping it low is likely temporary: the continued aggressive expansion of major central-bank balance sheets. Others may be longer-lasting: among them, the likelihood that repair of public and private-sector balance sheets will raise worldwide saving rates, and in Canada’s case, the increasing attractiveness of the Canadian dollar as a reserve currency. For this reason, even members who were less worried about adverse events abroad and more optimistic about a rapid closing of Canada’s output gap tended to call for only modest increases in the Bank of Canada’s policy rate over the next year.

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 January 17, 2013, prior to the Bank of Canada’s interest rate announcement on January 23, 2013.

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