{"id":298858,"date":"2024-02-08T20:15:14","date_gmt":"2024-02-08T20:15:14","guid":{"rendered":"https:\/\/wahi.com\/ca\/en\/?p=298858"},"modified":"2024-09-12T18:17:48","modified_gmt":"2024-09-12T18:17:48","slug":"what-you-need-to-know-about-the-bank-of-canadas-overnight-rate","status":"publish","type":"post","link":"https:\/\/wahi.com\/ca\/en\/learning-centre\/real-estate-101\/buy\/overnight-interest-rate-explainer\/","title":{"rendered":"What You Need to Know About the Bank of Canada\u2019s Overnight Rate"},"content":{"rendered":"

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We explain the relationship between the central bank\u2019s overnight rate and inflation \u2014 and what it all means for homebuyers and mortgage borrowers. <\/span><\/p>\n

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By Josh Sherman<\/a>\u00a0<\/span>| 5 minute read<\/p>\n

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The overnight rate is the Bank of Canada\u2019s number-one mechanism for guiding inflation in the economy<\/span>.<\/p>\n

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\u00a0<\/span><\/p>\n

Anyone who follows Canadian real estate<\/a> \u2014 or isn\u2019t completely disconnected from the news \u2014 has probably at least heard of the Bank of Canada\u2019s overnight rate.<\/span><\/p>\n

\u00a0<\/span><\/p>\n

Also known as the key interest rate, the overnight rate is set by Canada\u2019s central bank, a Crown corporation that acts with \u201cconsiderable independence\u201d from the federal government, eight times per year. These policy announcements create lots of fodder for headlines and commentary from experts, casual observers, and anyone in between. House hunters and owners typically cheer rate cuts and curse hikes, but what is the overnight rate, really?<\/span><\/span><\/p>\n

<\/span><\/p>\n

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“When interest rates go up, we\u2019ll try and cut back on little things before we make a serious change to our lifestyle decisions.”<\/strong><\/span><\/h2>\n

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In this blog post, Wahi helps homebuyers get so in the know by defining the overnight rate (without any jargon), explaining what it does (without any jargon), and laying out what changes to it mean for consumers (you guessed it \u2014 without any jargon).<\/span><\/p>\n

 <\/p>\n

The Overnight Rate: The Basics Explained\u00a0<\/b><\/h2>\n

<\/b><\/p>\n

<\/b>
<\/span><\/p>\n

For a no-nonsense definition of the overnight rate, Wahi turned to Moshe Lander, a senior economics lecturer at Concordia University, in Montreal. He told us what he says he tells his first-year students: \u201cIt\u2019s the rate at which banks can borrow and lend with other banks\u2026 at extremely short durations \u2014 in parentheses, overnight,\u201d he says. \u201cAll interest rates are tied to that [overnight rate],\u201d he adds.<\/span><\/p>\n

 <\/p>\n

The overnight rate is also the central bank\u2019s main tool for controlling inflation. Since the 1990s<\/a>, the Bank of Canada has aimed to keep inflation within a band of 1 to 3%. Lander likens this level of inflation to applying the right amount of grease to a wheel to keep it spinning. \u201cIf you have no grease on the wheel, that wheel is going to crack, it\u2019s going to break, and you\u2019re not going to be able to move. You put too much grease on the wheel, and it\u2019ll spin and gain no traction, and you won\u2019t be able to move,\u201d he tells Wahi. \u201cJust a little bit is enough, and it gives you a little bit of traction without the risk of it breaking \u2014 that\u2019s the inflation story,\u201d he adds.

<\/span><\/span><\/p>\n

<\/span><\/p>\n

How Does the Overnight Rate Impact Inflation?<\/b><\/h2>\n

\u00a0<\/span><\/p>\n

When demand for goods and services increase, prices increase \u2014 that\u2019s inflation. One way to reduce demand and curtail inflation is to increase the cost of borrowing money via a rate hike. \u201c<\/span>Doing so encourages financial institutions to increase interest rates on their loans and mortgages, discouraging borrowing and spending and thereby easing the upward pressure on prices,\u201d <\/span>according to the Bank of Canada<\/span><\/a>. (Conversely, in a recession the central bank can cut the overnight rate to try and spur economic activity.)<\/span><\/p>\n


However, experts note \u2014 and the central bank itself states<\/a> \u2014 that it takes time for rate changes to impact the broader economy, generally about 18 to 24 months to feel the full effects. \u201cThere\u2019s a common belief that the moment that the Bank of Canada adjusts the overnight rate, the inflation rate adjusts the following morning,\u201d says Lander, citing what he says is the biggest misconception Canadians have about the overnight rate.<\/span><\/p>\n

 <\/p>\n

Why the lag? There are four components to a macroeconomy, says Lander \u2014 households, businesses, governments, and foreigners. \u201cWhen you adjust interest rates, it affects all of them, but in different ways,\u201d he explains.\u00a0 \u201cBusinesses move quickly,\u201d he notes, adding that investment behaviour is particularly sensitive to rate changes. The same isn\u2019t true for everyone. \u201cConsumers are much slower to change their behaviour because we try to do everything we can to maintain a certain standard of living, a certain lifestyle,\u201d he says. \u201cSo, when interest rates go up, we\u2019ll try and cut back on little things before we make a serious change to our lifestyle decisions.\u201d<\/span><\/p>\n

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