C.D. Howe Institute’s Monetary Policy Council Urges Bank of Canada to Raise Overnight Rate to 0.50 Percent, With Increases to 1.50 in December and 2.50 Percent by May 2011

Toronto, May 27 — The C.D. Howe Institute’s Monetary Policy Council (MPC) today recommended that the Bank of Canada raise its target for the overnight interest rate (the very short-term money-market rate the Bank targets for monetary policy purposes) to 0.50 percent at its next announcement on June 1, 2010. The Council further recommended raising the target to 0.75 percent at the Bank’s subsequent announcement in July. The MPC’s recommendation for December 2010 was for a target of 1.50 percent and, looking one year ahead, for a target of 2.50 percent in May 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. Finn Poschmann, the Institute’s Vice President, Research, chaired the fifty-fifth meeting of the Council.

The MPC’s formal recommendation is its median vote. Nine of the eleven members attending the meeting recommended a target of 0.50 percent next week. For the announcement in July, however, the group was generally divided between those who favoured incremental increases, to 0.75 percent for the overnight rate target, and those who favoured a sharper increase, to 1.00 percent. Looking out to the December 2010 rate-setting meeting, recommendations ranged from 1.00 to 2.00 percent, and calls for May 2011 ranged from 1.50 to 3.50 percent.

Noting the recent withdrawal of the Bank of Canada’s prior conditional commitment to keeping its overnight rate target at 0.25 percent until later this summer, the group was unanimous in recommending a steady series of rate increases over the coming year, as the economy’s output moves nearer to its potential and withdrawal of monetary stimulus becomes increasingly appropriate. Debate centred on how quickly rates should increase.

Members favouring a slower pace of increase were primarily concerned by recent events in Europe and their impact on world financial markets and the global economy. Some concern was also expressed over the growth-slowing impact of several countries simultaneously withdrawing fiscal stimulus while also tightening monetarily.

Members favouring faster action pointed to recent strong retail sales data, strong labour market performance, as well as to a generally quick pace of housing price increases, (although the latter is expected to moderate by year end as demand and supply inventories move nearer to balance). Looking out a year, members of this group also recommended a time path for rate increases that would restore interest rates to a level more historically consistent with maintaining the 2 percent inflation target, in what would be, by then, an economy operating close to capacity.

As an operational matter, the group suggested that the Bank of Canada should raise its target for the overnight rate 25 basis points above the rate’s floor, either now or at its next decision date, so that the overnight rate can return to its normal place in the corridor whose upper limit is set by the bank rate.

The table shows the median votes and individual recommendations for the overnight rate at the June 1, 2010 setting and the July 20, 2010 setting, as well as the group’s views about the target in 6 and 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 July 15, 2010, prior to the Bank of Canada’s interest rate announcement on July 20, 2010.

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