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

July 12, 2012 — 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 it targets for monetary policy purposes, at 1.00 percent at its next announcement on July 17, 2012. The MPC further recommended that the Bank hold the overnight rate target at 1.00 through January of 2013, and called for a target of 1.50 percent by July of next year.

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 makes formal recommendations ­­– its median vote – for the Bank of Canada’s upcoming rate announcement, the subsequent announcement, the announcement in six months’ time, and the announcement in one year’s time. While all ten of the members attending the meeting called for a 1.00 percent target at the upcoming setting and nine of them supported a 1.00 percent target at the next setting in September, views diverged after that. Looking ahead to July 2013, only three of the members supported a target of exactly 1.50 percent: the full range of views ran from a low of 0.75 percent to a high of 2.50 percent.

In evaluating the near-term outlook for the Canadian economy, most members agreed that domestic demand looked robust, but that weakness in the United States and abroad would hurt Canadian growth more than appeared likely six weeks ago. They were also close to consensus on the likely damping effect of formal and informal changes in mortgage lending rules, which many members saw as mitigating pressure on the Bank to raise the overnight rate to restrain residential construction and consumer borrowing. While there was some debate over the size and significance of the disinflationary output gap in Canada, none of the group saw any appreciable near-term threat that the Bank would overshoot its inflation target.

The Council did disagree, however, about how the Bank should respond to three major downside risks to the outlook: fiscal and financial crises in Europe; the US “fiscal cliff” at the beginning of 2013; and a hard landing in China. Some members argued that the Bank of Canada should aim to return the overnight rate to a level more consistent with steady growth and inflation under non-crisis circumstances, while making clear its willingness and ability to reverse direction if a negative shock occurred. Others felt that these risks justified holding the overnight rate down, because these risks were already depressing confidence and spending, and if the Bank of Canada became relatively tighter than other central banks it could undesirably raise the foreign exchange value of the Canadian dollar.

Members of the latter group tended to feel that the Bank of Canada’s upcoming announcement should remove language indicating a bias toward less accommodative monetary policy in the months ahead. The majority of members, however, felt that a bias toward less accommodation should remain in the language, and thought that the overnight rate should return to more normal levels over time, a fact reflected in the median call for a rate of 1.50 percent by July 2013.

The table shows the median votes and individual recommendations for the overnight rate at the July 17, 2012  setting and the September 5, 2012 setting, as well as the group’s views about the target in 6 and 12 months’ time.

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 30, 2012, prior to the Bank of Canada’s interest rate announcement on September 5, 2012.

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