Bank of Canada Should Hold Overnight Rate at 1.50 Percent Next Week, Hike to 2.25 in a Year’s Time Says C.D. Howe Institute Monetary Policy Council

August 30, 2018 — The C.D. Howe Institute’s Monetary Policy Council (MPC) called for the Bank of Canada to hold its target for the overnight rate, its benchmark policy interest rate, at 1.50 percent at its next announcement on September 5, 2018. Looking further ahead, the Council called for a hike in the target to 1.75 percent in October, with further increases raising it to 2.25 percent by September of 2019.

The MPC provides an independent assessment of the monetary stance consistent with the Bank of Canada’s 2 percent inflation target. William Robson, the Institute’s President and CEO, chairs the Council. Council members make recommendations for the Bank of Canada’s upcoming interest-rate announcement, the subsequent announcement, and the announcements six months and one year ahead. The Council’s formal recommendation for each announcement is the median vote of the members attending the meeting.

The call for an unchanged overnight rate next week was almost unanimous: 11 of the 12 members wanted no change, and one wanted an increase to 1.75 percent. The call for a hike to 1.75 percent in October was almost as strongly supported: 10 members wanted it, and two wanted 1.50 percent. By March 2019, all members called for a higher overnight rate, with seven wanting 2.00 percent, and by September 2019, members wanted an overnight rate between 2.00 and 2.50 percent (see table).

The group’s support for a higher policy interest rate over time reflected its view that the Canadian economy is running at or above its productive capacity and that activity will likely continue increasing at least in line with growth in productive capacity, which means that inflation will run at 2 percent or above in the coming months. Strong indicators on employment and compensation, resilience in the housing market, and some recently better international trade numbers featured in this assessment, as did total CPI inflation well above target, and robust readings of consumer prices excluding food, energy and indirect taxes.

The greater dispersion of MPC members’ recommendations for the overnight rate further in the future reflected some divergence in views about economic activity, and also uncertainty about where the overnight rate would be in an environment of steady growth and inflation on target. Some members felt that the long-run “neutral” overnight rate might be as low as 2.50 percent; others noted that a rate so little above inflation would be problematically low in real terms. This discussion also affected the group’s views on how quickly the Bank of Canada should increase the overnight rate, since the term structure of interest rates is already quite flat, and a rapid increase in the overnight rate would invert it – typically a harbinger of recession.

Hesitation to raise the overnight rate immediately also reflected some near-term risks. Uncertainty about the NAFTA negotiations and possible new US trade restrictions was the major concern, with other global developments such as slower growth in China and problems in several emerging markets also figuring in the discussion. With some members expecting a relatively weak third quarter in Canada, and some difficulties interpreting some labour-force survey numbers, these concerns supported the near-consensus for no overnight rate change next week, followed by an increase in October.

Votes of MPC members and the Council median for each announcement, percent

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 18th, 2018 prior to the Bank of Canada’s interest rate announcement on October 24th, 2018. 

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