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

February 28, 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 March 6, 2013. The Council further called for the Bank to hold the target at 1.00 through to March of 2014.

The MPC is a C.D. Howe Institute project that provides an independent assessment of the Bank of Canada’s monetary stance as it pursues 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 interest-rate announcement, the subsequent announcement, and the announcements six months and one year ahead. On this occasion, eight of the 10 members called for a 1.00 percent target next week, while two called for the Bank to lower the target to 0.75 percent. The recommendations for the following setting in April were identical. By September 2013, one member wanted a target of 1.25 percent, while eight wanted 1.00 percent and one wanted 0.75 percent. By March 2014, one member wanted 1.50 percent, one 1.25 percent, and eight others 1.00 percent.

The fact that most of the group called for no change in the overnight rate, with some calling for a cut, reflected lackluster recent growth in the Canadian economy, and little near-term prospect that the current disinflationary output gap will close. Several members expressed doubts about the Bank of Canada’s forecast that inflation will return to target in 2014. The thrust of the conversation was rather that inflation had stayed surprisingly strong over the past few years, supported by commodity prices and inflation expectations well anchored at the 2 percent target, but was now falling as the output gap suggested it should – a tendency that may become clearer with revisions to the Canadian consumer price index beginning in March.

While they debated the timing and size of last year’s changes to mortgage reinsurance rules on the housing market, MPC members generally felt that Canadian households will not contribute much to growth through 2014. With governments retrenching, the recent intentions survey showing disappointing figures for business investment, and little prospect of significant support from net exports, they felt the Bank of Canada should stay accommodative.

The foreign exchange value of the Canadian dollar was a major topic of discussion at this meeting. Notwithstanding its recent small decline against the US dollar, the group generally judged the dollar to be stronger than macroeconomic conditions warranted, noting that aggressive easing by many foreign central banks, and a growing appetite for Canadian-dollar assets abroad, were keeping it high. The group showed little enthusiasm for currency-market intervention, but many members felt the goal of getting the dollar to a level more supportive of growth should guide the Bank of Canada’s interest rate policy, as well as its communications.

In connection with Bank communications, four MPC members felt that concern over the strong currency, and the goal of supporting growth more generally, would warrant removing the references to an eventual withdrawal of monetary policy stimulus that have been a regular feature of the Bank of Canada’s communications since the financial crisis. The other members, motivated in part by concerns about excessive household borrowing, felt that the Bank should continue to warn that short-term interest rates will eventually rise.

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 April 11, 2013, prior to the Bank of Canada’s interest rate announcement on April 17, 2013.

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