C.D. Howe Institute’s Monetary Policy Council Calls for Bank of Canada to Lower its Benchmark Interest Rate Target to 2.00 Percent

Toronto, October 16 — The C.D. Howe Institute’s Monetary Policy Council (MPC) today recommended that the Bank of Canada lower its target for the overnight interest rate by 50 basis points to 2.00 percent at its next announcement on October 21, 2008. The overnight rate is a very short-term money-market rate that the central bank targets for monetary policy purposes.

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 recommendation is its median vote. Six of the 10 members attending the meeting recommended cutting the rate to 2.00 percent, while three recommended a cut to 2.25 percent and one recommended holding the rate at 2.50 percent. Looking ahead to the Bank’s interest-rate announcement in December, the Council also recommended an overnight rate of 2.00 percent, and the median call for the rate in 6-12 months’ time was again 2.00 percent.

The Council’s discussion took place against an international and domestic backdrop of severe stress in credit markets and sharp downward revisions in expectations for real growth and inflation. The group noted that global growth is decelerating and that recent US indicators of economic activity have been very weak, creating a much less congenial environment for real growth in Canada. Falling commodity prices will hurt Canada’s terms of trade, and thus take away a key support for domestic income growth. Some members expect Canadian real GDP to fall in 2009, while nominal GDP may show almost no growth. These circumstances led the Council to conclude that more measures to support Canada’s financial system and real growth are needed.

One such measure unanimously supported by the group was a government guarantee of interbank lending. Notwithstanding the relatively strong position of Canadian financial institutions, members noted that government guarantees in other countries threatened to make Canadian institutions look like less attractive counterparties, which would exacerbate the stresses and high spreads afflicting the interbank market. The Council felt that a lending guarantee would create a more favourable environment for monetary stimulus by the Bank of Canada, and help ensure that movements in the overnight rate exerted their desired effect on interbank, business and consumer lending rates.

Looking ahead, the Council acknowledged that the turbulence in credit markets and the rapidly deteriorating economic outlook have created an extraordinarily wide range of uncertainty about the future paths of output and prices. Most members felt that the downside risks justified further ease from the Bank of Canada even after the coordinated central-bank cut of 50 basis points on October 8, 2008. Some emphasized that action to contain crises of confidence is more effective if taken quickly, and several noted that monetary policy is the most flexible tool of economic management at government’s disposal, and that the Bank can move swiftly to raise the overnight rate again if the extent of disinflationary pressure in the Canadian economy proves to be less than expected.

The recommendation of the MPC is the median of the votes cast by individual members attending the session. The table shows the median votes and individual recommendations for the overnight rate at the October 21, 2008 setting and the December 9, 2008 setting, as well as the group’s views about the target in 6-to-12 months’ time.

The views and opinions expressed by the Council’s members 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 4, 2008, prior to the Bank of Canada’s interest rate announcement on December 9, 2008.

* * * * *

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