What happens if the Bank of Canada raises or lowers interest rates?

If the economy struggles to grow or goes through a shock, such as during the COVID-19 pandemic, the Bank may cut interest rates to stimulate economic activity. When overnight interest rates fall, people and businesses pay a lower interest rate on new and existing loans and mortgages and earn less interest on savings. This generally leads them to spend more, which in turn helps strengthen the economy.

Conversely, an economy that grows too fast can lead to high inflation. In this scenario, the Bank may increase the overnight interest rate, forcing people and businesses to pay higher interest rates on loans and mortgages. This discourages them from borrowing, reduces overall spending and typically brings inflation under control.

How often does the Bank of Canada revise interest rates?

To help Canadians anticipate and prepare for changes in interest rates, the Bank introduced a schedule of eight fixed-rate policy announcements per year in 2020. It is on these specified dates that it reports whether or not there are any changes in the nightly rate. In special circumstances, such as national emergencies, it may announce rate changes on other unspecified dates, such as March 13 and 27, 2020, in response to COVID-19.

Historically, overnight interest rates have fluctuated based on large-scale events that affect the economy. After the financial crisis of 2008, the rate fell from 4.50% to 0.25%. Between 2010 and 2018, it gradually increased to 1.75%. Thereafter, it fell sharply in early 2020 in response to the pandemic.

What is the prime rate?

Not to be confused with the bank’s policy rate, the primary interest rate is a percentage used to set interest rates on various types of loans, including lines of credit, student loans, and variable-rate mortgages.

Each of the five major banks — Bank of Montreal (BMO), Bank of Nova Scotia (Scotiabank), Canadian Imperial Bank of Commerce (CIBC), Royal Bank of Canada (RBC), and Toronto-Dominion Bank (TD) — can create their own prime rate, but they tend to use the same rate. Today’s prime rate is 2.70%.

How is the prime rate determined?

Typically, when the Bank of Canada raises or lowers its overnight interest rate, prime rates are adjusted by a similar amount. Most lenders reset their prime rate almost immediately after the bank changes its benchmark rate.

That’s why changes in overnight interest rates create a kind of knock-on effect on floating-rate loans offered by banks – their interest rates are typically expressed as a “prime plus or minus” percentage. For example, a bank may offer a product at a rate of “prime minus 1%”. At a prime rate of 2.45%, a product listed at “prime minus 1%” would mean that the customer pays 1.45% interest.

This post How the Bank of Canada Interest Rate Works — and Why It’s Rising?

was original published at “https://www.moneysense.ca/save/financial-planning/financial-literacy-financial-planning/bank-of-canada-interest-rate/”