C.D. Howe Institute’s Monetary Policy Council Urges Bank of Canada to Maintain Overnight Rate at 0.25 Percent, With Increases to 1.25 in October and 2.50 Percent by April 2011

Toronto, April 15 — The C.D. Howe Institute’s Monetary Policy Council (MPC) today recommended that the Bank of Canada hold its target for the overnight interest rate (the very short-term money-market rate the Bank targets for monetary policy purposes) at 0.25 percent at its next announcement on April 20, 2010. The Council further recommended keeping the target at 0.25 percent at the Bank’s next announcement in June. The MPC’s recommendation for October 2010 was for a target of 1.25 percent and, looking one year ahead, for a target of 2.50 percent in April 2011.

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. Nine of the ten members attending the meeting recommended a target of 0.25 percent next week. For the announcement in June, however, the group was divided: while six recommended that the Bank hold the target at 0.25 percent, consistent with its conditional commitment to keep the overnight rate at its effective minimum through mid-year, two wanted a target of 0.50 percent in June, and two wanted a target of 0.75. Calls for the October setting ranged from a low of 0.75 percent to a high of 1.75 percent, and calls for April 2011 ranged between 1.50 and 3.25 percent.

The group’s discussion of the outlook for economic growth and inflation noted the strength of a number of recent indicators of spending and output, and the fact that inflation and inflation expectations were running higher than had been expected when the Bank of Canada first made its conditional commitment to hold the policy rate at 0.25 percent until mid-year.

Members who favoured the Bank staying with its commitment, and who tended to look for more gradual increases in the policy rate from July onward, tended to highlight the role of emergency stimulus and inventory swings in recent growth numbers, and pointed out that some recent spending in Canada might be a rush to beat anticipated interest-rate and consumption tax hikes. Some in this group also noted that the disappearance of one-time factors affecting prices will cause year-over-year inflation to moderate.

Members who wanted the Bank to raise the policy rate before mid-year and go higher faster after that tended to highlight the facts that, adjusted for inflation, the policy rate is now negative and will remain very low for some time to come, that domestic demand and inflation are running ahead of what was expected when the commitment was made, and that the yield curve and money growth rates are consistent with continued expansion.

One point of uncertainty for the group was the impact of fiscal policy at home and abroad. While several members mentioned fiscal consolidation as a potential negative influence on demand, there was a general concern that overly loose fiscal policy might force monetary policy to be tighter than would otherwise be necessary.

A major point of debate was the desirability of the Bank of Canada’s staying with its conditional commitment to keep the policy rate at 0.25 percent until July. Some members noted that the Bank’s ability to use such a commitment effectively again required it to see it through, absent more convincing evidence of higher-than-expected inflation. The possibility that an upward move ahead of July would send the Canadian dollar sharply higher was also mentioned.

In general, the strongest sentiment was that credibility in controlling inflation should be the Bank of Canada’s paramount consideration, and a number of members – including some who did not favour an overnight rate increase in June – urged that the Bank should not include a commitment to keep the rate unchanged in June in its communiqué. While several members had reservations about the Bank creating a new conditional commitment on interest rates for itself after mid-year, there was strong sentiment in favour of the Bank’s signaling clearly that monetary policy is likely to become much less accommodative as it exits its current emergency stance.

The table shows the median votes and individual recommendations for the overnight rate at the April 20, 2010 setting and the June 1, 2010 setting, as well as the group’s views about the target in 6 and 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 May 27, 2010, prior to the Bank of Canada’s interest rate announcement on June 1, 2010.

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