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Published On: Friday, 19 October 2018

Bank of Canada Should Raise Overnight Rate to 1.75 Percent Next Week, Hike to 2.50 in a Year’s Time Says C.D. Howe Institute Monetary Policy Council

Bank of Canada Should Raise Overnight Rate to 1.75 Percent Next Week, Hike to 2.50 in a Year’s Time Says C.D. Howe Institute Monetary Policy Council

CANADA - The C.D. Howe Institute’s Monetary Policy Council (MPC) called for the Bank of Canada to raise its target for the overnight rate, its benchmark policy interest rate, to 1.75 percent at its next announcement on October 24, 2018. Looking further ahead, the Council called for the Bank to hold the target at 1.75 percent in December, with subsequent increases raising it to 2.50 percent by October of 2019.

The MPC provides an independent assessment of the monetary stance consistent with the Bank of Canada’s 2 percent inflation target. Jeremy Kronick, an Associate Director, Research, at the C.D.

Howe Institute chaired the 122nd Council’s meeting. 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.

The call for an increase in the overnight rate next week was almost unanimous: eight of the nine members wanted an increase to 1.75 percent, and one wanted no change. The call for a hold at 1.75 percent in December was also strongly supported: six members favored it, one favored 1.50 percent, while two wanted a further hike to 2 percent.

By April 2019, all members called for a higher overnight rate, with six wanting 2.25 percent, and by October 2019, eight of nine members wanted an overnight rate between 2.25 and 2.50 percent (see table).

The group’s support for a rate hike next week reflected a reduction in trade uncertainty in light of the United States-Mexico-Canada Agreement (USMCA).

Trade uncertainty had been a roadblock to an otherwise strong Canadian economy. Both business investment and export data were strong, suggesting we may be nearing the desired rotation of the economy away from household consumption.

This rotation will continue to put upward pressure on productive capacity, and on inflation. While members did not expect headline inflation to continue at the 2.8 percent figure we saw in August, measures of core inflation all solidly at 2 percent suggest headline will continue to run above the 2 percent target.

The call for a hold in December reflects a number of potential concerns both domestically and abroad. The U.S. Fed continues to aggressively hike its overnight rate, which will put upward pressure on Canadian borrowing costs. These increased costs come on the heel of measures taken by both federal and provincial policymakers and regulators to put the brakes on the Canadian housing market.

Members taking a more cautious approach to rate hikes pointed to slower housing starts, and reduced auto sales as potential indicators of a weakening of the Canadian economy. Members also noted the trade war between the U.S. and China as another concern on the global front; a concern which has caused the IMF to lower its global growth forecast.

The call for further hikes down the road was a result of positive signs for the Canadian economy as we look ahead.  On investment, members mentioned the approval of the $40 billion LNG infrastructure project, and indications that the federal government will announce business competitiveness measures in the upcoming fall update. Members also pointed out that despite modest wage growth for salaried workers, there are indications of robust hourly wage growth. Future hikes would bring the Bank of Canada to the bottom of its neutral rate range.