There is a lot of talk out there about Canadian interest rates. A lot of this talk is because people are speculating on whether or not world governments, including Canada, will raise interest rates any time soon. An early increase in the interest rate could cause the stock market to fall substantially, as this is viewed as deflationary policy.
Interest rates in many countries are at all time lows. Governments use these rates as “instruments” with which they can alter the state of the economy to their liking. The changing of interest rates by the government is an aspect of monetary policy.
But before we get carried away, let’s go over a few of the key concepts.
Key Concepts
Bank Rate
As we can see above, the Bank Rate is the rate at which the Central Bank of a country lends to the commercial banks. In Canada, the Central Bank is the Bank of Canada (BoC). Prominent examples of commercial banks in Canada are the “big five”: RBC, BMO, TD, CIBC, and Scotiabank.
This rate is sometimes called the Discount Rate, especially in the United States.
Overnight Rate
The Overnight Rate is the interest rate at which the commercial banks lend to each other. The term “overnight” refers to the fact that the trading usually takes place at the end of the working day.
A concept related to the overnight rate is the Policy Rate. The policy rate is a rate at which the government wants to see the overnight rate. If there is a large enough deviation in this rate, the government will take action to move the overnight rate towards the policy rate.
Changing Rates
One of the aims of changing these interest rates is influencing the inflation in the economy. The Bank of Canada states:
We are Canada’s central bank. We work to preserve the value of money by keeping inflation low and stable.
Bank of Canada
When interest rates are low inflation eventually increases. When interest rates are high inflation eventually decreases. Remember, inflation has to do with how much money you pay for goods and services.
This makes a lot of sense when you think about it. When people have more money to spend because they are borrowing more, the economy grows and inflation increases. On the other hand, when people are hoarding money in their mattresses it is not being spent, the economy shrinks, and inflation decreases.
Presently, the government of Canada aims to sustainably maintain the inflation rate around 2% / annum. They do so by altering the Canadian interest rates, either directly or indirectly.
The State of Play – Recent BoC Announcement
Now that we’ve acquainted ourselves with these concepts we can delve into their current state. The Bank of Canada sends out updates on their operations eight times a year. As it happens today is one of those days. How exciting! During today’s announcement the Bank of Canada confirmed that it is holding the overnight rate target steady at .25% and the Bank Rate at .5%.
One thing which surprised some people is that the Bank of Canada now expects the economy to grow during Q1-2020. Previously, they stated that the economy would likely shrink during this period. This may alarm some people as it indicates more of a reason for the bank to raise their policy rate. However, the bank seems adamant that they are holding the policy rate steady at .25% for a long time coming (perhaps 2023 based on a “January projection”).
One funny thing to note is that the BoC still considers the “January projection” valid even now that they admit their January growth/contraction prediction for Q1-2020 was categorically wrong! We will see if their next long term projection changes. If it does, this would likely catalyze a change in the policy rate.
Of course it is always best to check out the source yourself. Again, it can be accessed at https://static.bankofcanada.ca/uploads/pdf/fad-press-release-2021-03-10.pdf
Up Next
The next announcement from the BoC is April 21, 2020. Be sure to keep your eyes peeled! Again, because of the degree of attention being paid to Canadian interest rates, any premature increase will likely cause your stock portfolio to fall.
Hopefully now you feel better prepared the next time someone is talking about “the interest rate”! Until next time,
Happy Investing.
