Mortgage Basics

Bank of Canada Interest Rate

Bank of Canada Interest Rate
Written by
  • Samson Solomon
| Nov 7, 2022
Reviewed, Jun 9, 2023

Key Takeaways

  • The Bank of Canada (BoC) carries out monetary policy by influencing short-term interest rates. It does this by adjusting the target for the overnight rate on 8 fixed dates each year.
  • Currently (as of December 2022), the Bank of Canada’s key policy rate is set at 4.25%, up 4% from May 2020, when it fell 1.50% at the onset of the pandemic.
  • The fluctuating key policy rate is the central bank’s main tool to help stimulate economic activity in response to market factors like inflation.
  • The key policy rate will directly affect other lending interest rates, like mortgages.

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What is the bank of Canada? 

The Bank of Canada is the country’s central bank. It was officially founded in 1935 and is designed to regulate and maintain Canada’s financial system and economy. Officially, through the Bank of Canada Act, its main undertaking is ‘to promote the economic and financial welfare of Canada.’

The Bank is also responsible for Canada’s monetary policy. It primarily does this by setting what’s known as the target overnight rate, which is more aptly known as the key policy rate. By changing this rate, the Bank can influence the money supply to help regulate the Canadian economy. The Bank of Canada is also responsible for issuing Canadian currency, managing foreign currency reserves, and supervising financial systems, funds transfers and retail payment systems through its various departments.

Latest Update – Bank of Canada Raises Interest Rate, Stands at 3.25%

Starting 2022 at 0.25%, the Bank of Canada has raised interest rates a total of 6 times this year, bringing the current rate to 3.75%.

After a long period of historically low rates, the Bank of Canada introduced the April, June, July and September rate hikes to tackle a superheated Canadian housing market and surging inflation. July was the single largest rise in the key policy rate since 2000 (typically, rates increase around 0.25% each time), but this past July, we saw an oversized hike of 1%.

What is the Target Overnight Rate?

The Target Overnight Rate, also known as the Key Policy Interest Rate, is the primary tool used by the Bank of Canada (BoC) to control inflation domestically. Making it the starting point for setting many interest rates across the Canadian economy. The Consumer Price Index primarily measures inflation.

The Target Overnight Rate doesn’t affect the general public directly, but it does affect the overnight market. The overnight market is how Canadian Financial Institutions settle payments and funds transfers between each other at the end of each business day.  Each day clients at various banks and credit unions will transact through bill payments, debit and other transfers between each other.  

All these transactions will need to be settled between them – even international wire transfers settling through correspondent arrangements made at one of the Canadian Financial Institutions. While some may have a net deficit between their transfers – these institutions will borrow money from each other through the central bank at the overnight rate on the overnight market.  The central bank sets the target overnight rate as a ‘target’ for the amount financial institutions should charge in interest when lending these overnight loans – aptly called the Target Overnight Rate.

Bank of Canada Overnight Rate Changes Since 2010

For the last 12 years, the key policy rate has gone no lower than 0.25%. For over half of 2020 and all of 2021, the BoC’s Key Policy Overnight Rate remained at 0.25%. At the time of this update, the rate sits at 3.75%, with some anticipating further increases in 2023 to curtail rising inflation and housing costs.

Bank of Canada Overnight Rate Forecast – 2023

In October of 2022, the Bank of Canada took a 45-degree turn saying that one of its core inflation measurements, CPI-common, may be broken.  The flaws were showing up when rates surged so quickly.  CPI-common is a measure of core inflation that tracks common price changes across categories in the CPI basket. It uses a statistical procedure called a factor model to detect these common variations, which helps filter out price movements caused by factors specific to certain components.

The central bank has concluded that it will remove CPI-common from its inflationary measurements, thus raising expectations of further rate hikes with the new modelling.  With this new tone, we expect further rate hikes through 2023 in line with most economists and financial experts in this niche field.  Most Big 5 banks forecast that by the end of 2024, they expect the Bank of Canada to have inflation in control and rates to start heading downwards.

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Bank of Canada Overnight Rate History

The Bank of Canada was Created in 1935

After the Great Depression in North America, the Bank of Canada Act was introduced towards the end of 1934. The Bank of Canada was founded the following year in response to the economic fallout of the Great Depression. In March 1935, the Bank of Canada was opened to public investors, and shortly after was nationalized as a crown corporation in 1938. 

1935 – 1945: The Great Depression and World War II

The Great Depression was a global social and economic crisis in the early 1930s. Canada, in particular, was badly affected by high unemployment, bankruptcy and homelessness at the time. The Bank of Canada’s interest rate began at 2.5% in 1935. By the end of World War 2, it had dropped to 1.5%, and the economy had strengthened significantly during the war.

1945 – 1955: The Post-War Period

The Bank of Canada rate did not rise again until October 1955, when it increased to 2.0%. In the wake of the second world war, the Canadian economy developed considerably, particularly in the primary sector (raw materials) and secondary sector (manufacturing). The low-interest rates after the war helped Canadians invest in infrastructure, housing, and consumer goods.

1977 – 1991: Stagflation

Generally, unemployment and inflation have an inverse relationship. When more people are employed, inflation is generally higher as spending increases overall. Stagflation is a term in economics that describes a situation where both unemployment and inflation are high, alongside slowing economic growth (sound familiar?). 

After a period of sustained growth after the war, the Bank of Canada rate continued to experience trend growth to the 1980s, when the rate finally peaked at 20.03% in August 1981, an all-time high since the Bank’s inception. After this, the rate fluctuated between 15% and 7.5% in the late 80s and early 90s.

1991 – 2008: Economic Recovery

Since the early 90s, the Bank of Canada rate has trended downwards, with some periods (e.g. the late 90s) in which the rate spiked before gradually falling again. Target inflation figures were introduced by the Canadian government in 1991 and have been reviewed periodically since then (currently set at 2%).

2009 – 2017: The Financial Crisis

The 2007-2009 financial crisis resulted from years of cheap credit and relaxed lending standards that fueled a housing bubble, which eventually burst, resulting in major financial institutions in North America being left with trillions of dollars of toxic debt, in the form of subprime mortgages. The Bank of Canada immediately lowered the key policy rate in response to the collapse, down to 0.5% in March 2009, the first time the rate had ever fallen below 1%. Since then, the rate has hovered within roughly 0.75% of the 1% mark. 

2018 – 2022: COVID-19 + Inflation

Before the global pandemic, the Bank of Canada’s rate held steady at around 1.75%. On the onset of the pandemic in North America, over 11 days in March 2020,  the rate was lowered by 150 percentage points (1 percentage point is 0.01%)  from 1.75% to 0.25% in step with our American counterpart, the Federal Reserve. 

Rates remained at this historic low until March of this year, when they started to rise again to tackle growing inflation gradually. There was a 25 bps (1 bps is equal to 1 percentage) increase in March and another 50bps in April, bringing the rate to 1.00%.

In their April 13 release, when the 1.00% rate was introduced, the Bank of Canada stated the following: “with the economy moving into excess demand and inflation persisting well above target, the Governing Council judges that interest rates will need to rise further.” Once again, in June 2022, the overnight rate was increased once again by 50bps bringing it to 1.50%. July of this year saw a supersized increase of 100bps to bring the Target Overnight Rate to 2.50%.

As forecasted by the markets, once again Bank of Canada raised the target for its overnight rate by 75bps to 3.25% in September 2022, with other 50bps raise to land at 3.75%. Policymakers have said that interest rates will need to rise further given the inflation outlook, with surveys suggesting that short-term inflation expectations remain high. Adding that the Canadian and global economies are evolving broadly in line with their July projection and that COVID-19 outbreaks, ongoing supply disruptions, and the war in Ukraine continue to dampen growth and boost prices.

Currently, inflation, according to the Consumer Price Index is 6.9% and is at its highest gain in the index since 1991. To round out 2022, the BoC has increased the overnight rate by 50bps in October and December to end the year at 4.25%. More rate hikes are possible for the beginning of 2023.

Frequently Asked Questions

Why is the Bank of Canada’s Target to Key Policy Overnight Rate Important?

The Bank of Canada’s main tool to control inflation is the target overnight rate—also called the policy interest rate or key interest rate. This is the starting point for many of the economic interest rates that matter to Canadians, like mortgage interest rates. Ultimately, the Bank uses the key policy rate to pull down or help increase interest rates across the economy to regulate inflation. 

Think of the target overnight rate as the brakes or accelerator on the economy. When inflation rises above the government’s target of 2%, the Bank raises the policy rates and applies the brakes to reduce spending. When inflation falls too low (which can also have negative consequences), the bank steps on the gas and lowers interest rates, helping stimulate economic spending.

Why Doesn’t the Bank of Canada Issue Negative Rates?

Negative interest rates are an unorthodox form of monetary policy where interest rates fall below 0%. This means borrowers will be credited interest instead of paying it to lenders. An issue with negative interest rates is that banks cannot pass on the cost of the negative rate to their customers. Such a policy can cause issues in the market, and as a result, the governor of the Bank of Canada has decided against using negative rates for now.

Japan has been using negative interest rates since 2016, creating stagnant consumer prices and deflation stifling wages and corporate investment – which has severely affected its economic growth. However, in a 2015 paper on Negative Policy Rates by the Bank of Canada, the author argues there is little evidence to suggest negative rates create significant market volatility or disruption and has cited the examples of several banks (notably in Europe) that have used the policy with some effectiveness. Ultimately, though, the author suggests that more time is needed to study the overall impacts of negative rates.

How Does the Overnight Rate Work?

The Bank of Canada sets the overnight rate as a target for the amount of interest that financial institutions should charge each other in interest when borrowing and lending to balance their transactions at the end of each business day. 

The overnight rate stimulates the economy by promoting spending when inflation is low or reducing spending when inflation is high. Generally, increases in the target overnight rate have a knock-on effect on the public. Financial institutions will increase their interest rates – like those on mortgages – in response to a rise in the Bank of Canada’s key policy interest rate. 

Final Thoughts

The Bank of Canada target overnight rate, otherwise known as the key policy rate, or more colloquially, the Bank of Canada interest rate, is an important fiscal policy instrument. It can be considered the central interest rate for other financial institutions that borrow money from the government’s central bank. 

The key policy rate influences several other rates, such as savings rates and, most importantly, mortgage rates. While several factors influence mortgage rates in Canada, the overnight rate has a significant impact. 

With rates expected to rise til the end of 2024, now could be the right time to lock in the best mortgage rate possible. Get in touch with our team to learn more and have our commission-free expert and qualified mortgage advisors find the best mortgage solution for your unique situation.

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