C.D. Howe Institute Monetary Policy Council: Bank of Canada Should Hold Overnight Rate at 0.50 Percent for Six Months, Hike to 0.75 Percent by October 2017

October 13, 2016 — The C.D. Howe Institute’s Monetary Policy Council (MPC) today called for the Bank of Canada to keep its target for the overnight rate, the very short-term interest rate it targets for monetary policy purposes, at 0.50 percent at its next announcement on October 19, 2016.  Looking ahead, the Council said the Bank should hold the target at 0.50 percent over the next six months, and called for an increase to 0.75 percent in a year’s time.

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.

On this occasion, the call for the Bank to hold the target at 0.50 percent until April 2017 was unanimous. The call for a hike to 0.75 percent by October 2017 was a close decision, with five of the nine members attending the meeting preferring that level, and four preferring a rate unchanged at 0.50 percent (see table below).

MPC members’ strong tendency to favour an unchanged overnight rate for a prolonged period reflected a balance of considerations. Looking abroad, the world economy and the United States in particular continue to expand at a moderate pace, and higher oil prices improve the environment for Canada. More negatively, global trade and capital investment in major countries are disappointingly sluggish, and members underlined policy concerns, including the growing likelihood of a “hard” Brexit and uncertainty about the fall elections in the United States. On the domestic front, members expected demand and output to grow in the second half of 2016 and into 2017, but noted that business investment does not seem to be responding to capacity constraints, with negative implications for Canada’s future productive capacity. The outlook for inflation and inflation expectations reinforced the group’s tendency to recommend an unchanged target, with slow increases in wages and “core” inflation balanced by the prospect of higher energy prices.

In thinking about the timing of a potential change in the target over the next 12 months, several members noted that recent changes in the rules for federal-government mortgage insurance would mitigate the risks of Canadian households becoming further indebted, removing one reason for the Bank of Canada to hike earlier. Members also noted the desirability of seeing when, and by how much, government spending on infrastructure would actually affect activity. A further consideration was the probability of an increase in the US Federal Funds rate, which might lower the value of the Canadian dollar against the US dollar, supporting Canada’s net exports. While a majority of members felt that an eventual move to a more normal level of interest rates made sense, considerations of timing as well as the fine balance of views about output and inflation left the group barely calling for an increase to 0.75 percent in a year’s time.

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 December 1, 2016 prior to the Bank of Canada’s interest rate announcement on December 7, 2016.

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