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

July 11, 2013 — 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 July 17, 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 July 2014.

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 Chief Executive Officer, chaired the Council’s 79th 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, all 10 members attending called for a 1.00 percent target next week, and for the settings in September 2013 and January 2014. For the July 2014 setting, five members called for 1.00 percent, while three called for 1.25 percent, one for 1.50 percent and one for 1.75 percent. When, as in this instance, the median is between two numbers (1.00 and 1.25 percent), the formal recommendation is rounded in the direction of the mean vote: 1.25 percent.

The group’s unanimity on the desirability of a steady 1.00 percent target until 2014 largely reflected a view that moderate growth in demand will not close the disinflationary output gap in the Canadian economy until well into 2015. A rise in the overnight rate to a level consistent with steady real growth and inflation at 2 percent is therefore not warranted for at least a year.

Both international and domestic factors supported the view that growth will continue, but at a subdued pace. Overseas, the group noted that Chinese growth is slowing, while Europe and Japan should benefit from stimulative monetary policy. The group’s assessment of the US situation was similarly mixed: on the positive side, rising private-sector spending – particularly in sectors that tend to draw in imports from Canada; on the negative side, a higher exchange rate for the US$, a run-up in longer-term interest rates that may damp demand, and fiscal uncertainty.

On the domestic scene, members tended to emphasize the likelihood of moderation in residential construction and mixed signals on output and employment. The fact that the consumer price index has continued to register unexpectedly small increases, and that indicators of inflationary pressure at home and abroad are also very subdued, was a major theme in the group’s discussions, and accounts for its lack of enthusiasm for an early increase in the overnight rate target.

The MPC devoted considerable attention to the Bank’s challenge in communicating the fact that the overnight rate will eventually need to rise to more normal levels, without creating expectations that will damp overall activity in the medium term or appear to tie its hands in the event of negative developments that would warrant a rate cut. The group was split on whether the Bank should remove the language from its communiqué that anticipates a rise in the overnight rate. Four of the members felt that the Bank should eliminate any language that suggested a tightening bias. Among those who felt such language belonged in the communiqué, several felt that the Bank should continue to say the rate must rise eventually, while making clear that this longer-term trend does not mean its next move will necessarily be to raise it. 

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 August 29, 2013, prior to the Bank of Canada’s interest rate announcement on September 4, 2013.

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