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

August 29, 2013 — The C.D. Howe Institute’s Monetary Policy Council (MPC) today recommended that the Bank of Canada keep 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 September 4, 2013. The Council further called for the Bank to hold the target at 1.00 through to early 2014, before raising it to 1.25 percent by September 2014.

The MPC is a panel sponsored by the C.D. Howe Institute to provide an independent assessment of the monetary stance appropriate for the Bank of Canada as it aims for its 2 percent inflation target. William Robson, the Institute’s President and Chief Executive Officer, chaired the Council’s 80th meeting.

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 interest-rate announcement, the subsequent announcement, and the announcements six months and one year ahead. On this occasion, 10 of the 11 members attending called for a 1.00 percent target next week and at the following setting in October, while one called for a 0.75 percent target at both settings. For the March 2014 setting, nine members called for 1.00 percent, and two called for 1.25 percent. Looking a year ahead, five members urged an overnight-rate target of 1.00 percent, five urged 1.25 percent and one urged 1.50.

The strong majority calling for an overnight rate target of 1.00 percent until early 2014 reflected the group’s judgement that growth of demand in Canada will be subdued for some time, and that the disinflationary gap between the economy’s productive potential and actual output will therefore close slowly, if at all. Under those circumstances, inflation should also remain subdued, making a rise in the overnight rate to a level consistent with steady real growth and inflation at 2 percent unwarranted until well past the MPC’s one-year time horizon.

Both domestic and international factors supported the group’s subdued assessment of Canada’s growth prospects. Scanning recent mixed news from Canadian indicators of spending, employment and confidence, the group felt that demand would likely grow, at best, in line with productive capacity through the end of the 2013.

Looking abroad, they noted a deceleration of the US recovery, and the potential for higher long-term interest rates – and, more speculatively, fiscal disruptions – to sap US strength in the months ahead. While recent indicators from Europe have been somewhat better, the Eurozone’s financial and fiscal difficulties are unresolved. Slower growth in China, signs of turbulence in many emerging markets, and the possibility of escalating conflict in Syria and higher oil prices reinforced the caution.

The fact that positive expectations for growth – on the part of forecasters globally, by the Bank of Canada, and among members of the MPC itself – have been so regularly disappointed over the past few years was a major theme of the conversation. Many members felt that these disappointments showed that uncertainty and the burden of high leverage were creating worse headwinds for monetary policy than expected.

A second major topic of discussion was the degree to which the Bank of Canada should signal its future intentions about the overnight-rate target, and the extent to which its forward guidance should be explicitly conditioned on economic developments. There was no consensus on the desirability of more explicit guidance about the path of the overnight rate – nor, given the group’s ambiguous views, about whether the bank should emphasize the likelihood of a move up as opposed to more balanced risks. Some members noted, however, that with the Canadian dollar having weakened, and higher long-term interest rates mitigating concerns about the distorting effects of prolonged low interest rates on financial-sector and consumer balance sheets, the need for the Bank of Canada to give more explicit guidance had at least temporarily diminished.

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

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