The C.D. Howe Institute’s Monetary Policy Council today recommended that the Bank of Canada raise its target for the key overnight interest rate to 3.25% when it makes its next announcement on December 6.

The group unanimously called for a 25 basis-point increase in the overnight rate at the December 6 setting. Members saw recent indicators of strong demand in Canada and the United States as harbingers of continued pressure on Canada’s productive capacity. Although some price measures remain well behaved, the group highlighted continued upward movement in inflation expectations as a source of concern, especially if those higher expectations reflect eroding confidence in the inflation target itself.

When asked for their views about the following interest rate setting in January, nine of the 10 members in attendance voted for a further increase in the overnight-rate target to 3.5% at that time.

The group considered the possibility of a 50 basis-point hike in the overnight-rate target in December, rather than risking staying “behind the curve” and letting inflation expectations get further out of hand. Such a step did not find favour, partly because market participants expect 25 basis-point moves, and partly because of the risk that it would produce an undesirable upward spike in the exchange rate. Most members felt, however, that even if the overnight rate moved to 3.5% in January, the Bank of Canada would still need to further reduce its monetary stimulus in the following months.

Members of the MPC were also asked for their preferred level for the Bank of Canada’s overnight rate target at its next setting in January 2006, based on information currently available and assuming their individual recommendations for the upcoming setting were followed. The median response was 3.50%.

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% inflation target.