The C.D. Howe Institute’s Monetary Policy Council (MPC) is recommending that the Bank of Canada raise its target for the key overnight interest rate to 3.5% when it makes its next announcement on January 24.

Nine of the 11 MPC members attending the session called for a 25 basis-point increase in the overnight rate at the upcoming rate setting. They indicated that they felt that short-term interest rates are below the levels compatible with a sustained 2% inflation rate.

“Most looked for continued growth in demand at, or above growth in Canada’s productive capacity, especially given bottlenecks in some areas arising from regional and sectoral shifts in activity,” it reported. “Several pointed out that data on capacity utilization and the unemployment rate indicate tightness in markets for goods and services and for labour that, in the past, have been associated with excess demand and subsequent increases in inflation.”

“Evidence from surveys and financial markets that inflation expectations are high relative to the Bank’s 2% target also prompted concern – so much so that two members wanted to see a 50 basis-point increase in the overnight rate at the upcoming setting,” it noted.

Looking ahead to the March rate setting, eight of the nine members who voted for a 25 bps increase next week voted for a further 25 bps increase at the March meeting. One would leave rates unchanged. Also, both members who voted for a 50 bps increase next week also wanted to see a further 25 bps hike in March.

The group noted that recent measures of consumer price inflation and other costs have been more subdued than many forecasters predicted. While acknowledging that these lower-than-expected outcomes might reflect less pressure on capacity than other indicators suggest, many felt that the past appreciation of the Canadian dollar contained price increases that would come through if the exchange rate were to stabilize. Therefore, they thought it was too soon to draw firm conclusions about the Canadian economy’s ability to grow consistently faster without rising inflation.