The Prime Rate might go Up

May 26, 2011 — 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 1.25 percent at its next announcement on May 31, 2011. The Council further recommended raising the target rate to 1.50 percent at the following announcement on July 19, 2011, followed by increases that would take it to 1.75 percent in December 2011 and 2.25 percent in May 2012.


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 recommendation for May 31 reflected a split between 7 members urging an increase to 1.25 percent and 5 urging no change. Differences in members’ assessments of the outlook for growth and inflation, and in the balance of risks affecting each, showed clearly at the 12-month horizon, with 7 members looking for an overnight rate of 2.00-2.25 percent in May 2012, and 5 looking for a rate in the range between 2.75 and 3.25 percent.

On this occasion, the general tone of the MPC’s discussions about growth globally and in Canada was more somber than at its last meeting in April – a change reflected in a downward move in the median call for the overnight rate in a year’s time from 2.50 percent at the April meeting. Several members emphasized signs of weakness in the United States, Europe and Japan, and slowing growth elsewhere, and the possibility that a strong reading for Canadian GDP in the first quarter of 2011 will be followed by a much weaker second quarter. The likelihood of a sovereign-debt-triggered banking crisis and the potential negative impact on growth as governments withdrew macroeconomic stimulus were prominent risks in the minds of many MPC members recommending no increase in the overnight rate on May 31^st.

These concerns did not, however, undermine a consensus that the Bank of Canada should raise its policy rate before long. Members urging the Bank to move sooner and further argued that inflation and at least short-term inflation expectations in Canada are above the Bank’s 2 percent target. They felt that by the time the disinflationary output gap disappears, which they predicted by mid-2012 at the latest, the overnight rate should be at or close to the level consistent with that target.

Several members of the group thought that the Bank of Canada needed to communicate better its own views about the medium- and longer-term path for policy. The Bank’s forecast of the output gap suggests that the policy rate should be at a neutral level by mid-2012, and its commentary on current conditions suggests that it sees the current policy rate as well below the neutral level – yet it has not prepared market participants for the repeated increases in the overnight rate in late 2011 and 2012 these circumstances would warrant. While the group felt that the Bank’s credibility on inflation control is high, most wanted more explanation of its views on the stable level of the overnight rate, and many felt that prompt movement toward that level would ensure the Bank’s credibility stayed intact.