The 2022 federal budget made way for a new tax-free savings account (TFSA) designed specifically for first-time home buyers in Canada. The account ultimately combines the advantages of the existing TFSA and registered retirement savings plan (RRSP) – popular down…
- The Bank of Canada periodically sets a central interest rate, known as the target overnight rate, or key policy rate.
- Currently, the Bank’s key policy rate is set at 1.00%, as of April 2022. It is expected to rise further before the end of the year.
- The key policy rate is designed to help stimulate economic activity in response to market factors like inflation.
- The key policy rate can have a knock-on effect on other lending interest rates, like mortgages.
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, according to the Bank of Canada Act, the Bank’s main job is ‘to promote the economic and financial welfare of Canada.’ The Bank is also responsible for Canada’s monetary policy, and primarily does this by setting what’s known as the ‘overnight rate’, or 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 retail payment providers.
Latest Update – Bank of Canada Raises Interest Rate From 0.50% to 1.00%
After raising the key interest rate in March, the Bank of Canada announced a further increase of 50 basis points on April 13, 2022, bringing the current interest rate to 1.00%. After a long period of historically low rates, the Bank of Canada introduced the most recent rate hike in an effort to tackle a superheated Canadian housing market and rising inflation. It is the single largest rise in the key policy rate since the year 2000 (typically, rates increase around 0.25% each time). The next interest rate announcement will be on June 1, 2022.
How the Bank of Canada Decides Its Target Overnight Rate
The overnight rate has a lot to do with inflation, as measured by the Consumer Price Index. At the root of the overnight rate is something known as the overnight market. While this isn’t something that involves the general public (in that they cannot borrow money on this market), it has a lot to do with all other interest rates in the economy. Every business day, Canadian financial institutions move money between their customers and other institutions. At the close of each business day, the millions of transactions that happen need to be settled. While some institutions send out more in payments than they receive, others receive more than they send out. To balance out these payments, financial institutions can borrow money from one another in what’s known as the ‘overnight’ market’ (hence the name, overnight rate). The Bank of Canada sets the target overnight rate as a ‘target’ for the amount that other financial institutions should charge in interest when lending these overnight loans.
Bank of Canada Overnight Rate Changes Since 2012
For the last 10 years, the key policy rate has gone no lower than 0.25%, and no higher than 1.75%. On average, since 2021 the overnight rate has been 0.86%. Currently, the rate sits at 1.00%, with some anticipating further increases in 2022 to curtail rising inflation and housing costs.
Bank of Canada Overnight Rate Forecast – 2022
As of April 2022 the overnight rate is 1.00%. Further increases in the policy rate are dependent on the Bank of Canada’s own assessment of the economy and its attempts to reach a 2% inflation target. 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.’ Given that Canada is currently experiencing strong growth, and with inflation at nearly 6%, it’s likely that we’ll see further increases in the key policy rate before the year ends. Taking into account the country’s current economic trajectory, we may see rates hit the 1.5-1.75% mark before the end of 2022.
Bank of Canada Interest Rate Forecast for the Next 5 Years
Bank of Canada Overnight Rate History
Bank of Canada Created in 1935
After the events of 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 levels of unemployment, bankruptcy and homelessness at the time. The Bank of Canada 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. Typically, when more people are employed, inflation is generally higher as spending is increasing overall. Stagflation is a term in economics that describes a situation in which both unemployment and inflation are high, alongside slowing economic growth.
After a period of sustained growth after the war, the Bank of Canada rate continued to experience trend growth all the way to the 1980s, where 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 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 has been reviewed periodically since then (it is currently set at 2%).
2009 – 2017: The Financial Crisis
The 2007-2009 financial crisis was a consequence of 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: COVID19 + Inflation
Before the global pandemic, the Bank of Canada’s rate held steady at around 1.75%. However, once the pandemic struck, the rate was lowered to a staggeringly low 0.25% almost overnight. COVID19’s sudden onset and subsequent lockdown of the Canadian economy drove the government, and the Bank, to lower interest rates by two 50 basis points in March 2020, months after the pandemic began. Rates remained at this historic low until March of this year, when they started to gradually rise again to tackle growing inflation. Currently, inflation according to the Consumer Price Index is 5.7%, the highest gain in the index since 1991.
Frequently Asked Questions
Why is the Bank of Canada 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 interest rates in the economy that matter for Canadians, like interest rates on mortgages. Ultimately, the Bank uses the key policy rate to pull down, or help increase, interest rates across the economy, in an effort to regulate inflation. Think of the target overnight rate as the brakes or accelerator on the economy. When inflation is rising at a rate above the government’s target of 2%, the Bank raises the policy rates and applies the brakes to make spending go down overall. When inflation falls too low (which can also have some negative consequences), the bank steps on the gas and lowers interest rates, helping stimulate spending in the economy.
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%. Essentially, 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.
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 during the business day. The overnight rate is designed to stimulate 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 to the public, as financial institutions will increase their own interest rates – like those on mortgages – in response to a rise in the Bank of Canada’s rate.
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 looked at as the central interest rate for other financial institutions who 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 throughout 2022, now could be the right time to lock in the best mortgage rate possible. To learn more, get in touch with our team, and a trained mortgage advisor will help you find the best solution for you.
Ready to get started?
In just a few clicks you can see our current rates. Then apply for your mortgage online in minutes!
Related articles in: Mortgage Basics
Montreal Housing Market Outlook 2022
Key Takeaways Montreal has experienced rapid growth in house prices for most residential categories from 2020-2022.The average sold price of a home in Montreal in March 2022 was $587,415, an increase of 14% year-over-year.Montreal’s sales-to-new listing ratio (SNLR) currently sits…
Should You Pay Property Taxes with Your Mortgage?
Whether you should pay your property taxes with your mortgage so that your lender pays the municipality on your behalf or if you make property tax payments straight to your city is an age-old debate. While first-time home buyers are…