C.D. Howe Institute’s Monetary Policy Council Urges Bank of Canada to Hold Overnight Rate at 1.00 Percent on October 25, 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 recommendations for each announcement date are its median votes. The recommendations for an unchanged target on October 25 and at the following announcement in early December reflected a balance: for the upcoming rate setting, five of the seven members in attendance called for no change, with one urging an increase to 1.25 percent and one a cut to 0.75 percent; for the December setting, four called for a target of 1.00 percent, while two wanted 1.25 percent and one 0.75 percent. The group unanimously called for the overnight rate target to rise over a 12-month horizon, anticipating a gradual dissipation of some of the uncertainties currently afflicting the world economy, and a resumption of moderate economic growth in Canada and abroad.

As for the nearer term, the split decision reflected a number of uncertainties and tensions. Since the Bank of Canada’s last policy rate setting in early September 2011, many of the indicators of demand and output in North America have come in at the strong end of – admittedly subdued – expectations, and consumer price inflation has been stubbornly high. (Some in the group said they expected Canada’s CPI release on October 21 to register a year-over-year increase of 3.0 percent – at the top of the error band around the 2 percent target – or more). MPC members leaning toward an increase tended to highlight the distorting effects of prolonged very low interest rates on the economy, such as much increased variable-rate mortgage financing and overinvestment in residential real estate. Financial-market and survey indicators of sentiment, by contrast, appear to prefigure slower spending and scaled back investment intentions, while both survey and market indicators of inflation expectations have moderated. On the whole, this mixed picture increased the group’s comfort with a gradual return of the overnight rate to a level consistent with longer-term, stable-inflation growth.

A particular tension in the discussion related to the Bank of Canada’s need to balance the imperative of inflation control against a material risk of bad news from abroad – with a deepening of the European crisis being the main concern, and an abrupt slowdown in China lurking in the background. Some MPC members felt that the Bank of Canada needed to put its inflation target unambiguously first, and begin raising the overnight rate to contain price pressures and maintain its credibility – all the more important in a run-up to a new monetary policy framework agreement that has yet to be announced. Others emphasized the risks to the Bank’s credibility posed by overnight-rate increases followed in short order by decreases prompted by a deteriorating environment abroad. They argued that an abrupt reversal could make market participants and the public doubt the Bank’s competence, and intensify feelings of crisis. This concern also shaped the Council’s overall view that the return of the overnight rate to a more normal level ought to be gradual.

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 December 1, 2011, prior to the Bank of Canada’s interest rate announcement on December 6, 2011.

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