The Bank of Canada (BoC) is standing pat on interest rates; this announcement was made last week Wednesday. Canada’s central bank is leaving the overnight lending rate at 0.5 percent. While some economists speculated that another rate cut was possible, the BoC seems fine with leaving interest rates where they are for the time being.
2015 was quite a year for the BoC. After leaving interest rates frozen for nearly five years (the longest stretch in Canadian history) at 1 percent, the BoC cut interest rates – not just once, but twice. In a surprise move, the BoC cut interest rates to 0.75 percent in January 2015 and 0.5 percent in July 2015.
What is the Overnight Lending Rate?
The overnight lending rate is a term synonymous with the key interest rate or key policy rate. The rate is used by the BoC to carry out monetary policy. It is also the rate banks use to borrow and lend one-day funds to one another.
The BoC has a set schedule with eight interest rate announcements per year. The overnight lending rate can be influenced by a wide variety of factors, including the economy, inflation, exports, and consumer debt, to name a few.
What Interest Rates Mean to Families
You may be wondering why interest rate announcements get so much media attention. Interest rates affect our lives more than you think. Banks set prime rate based on the overnight lending rate. When the BoC changes the overnight lending rate, the banks are likely to follow. For example, at an overnight lending rate of 0.5 percent, most of the big banks are offering a prime rate of 2.70 or 2.75 percent. When the banks lower prime rate, anyone with debt tied to prime benefits. Examples include variable rate mortgages, home equity line of credit, car loan, line of credit and student loan. A lower prime rate means more of your money goes towards principal and less towards interest.
A Tough Decision
Economics were split about whether the BoC would cut interest rates a further 25 basis points this time. With two interest rate cuts in 2015, the fear of economists is that the last two rate cuts didn’t have the full time to trickle through the economy. That doesn’t mean Canada is out of the woods yet – there are still seven more chances for the BoC to cut rates in 2016. With the economy tethering on the edge due to the weak oil prices and lower dollar, it’s anyone’s guess which way the BoC would go.
Although an interest rate cut could stimulate the economy, the biggest worry of our central bank is that Canadians will get further into debt. With the household debt-to-income ratio near a record of 163.3 percent, Canadians are piling on debt like never before. There was speculation that if the BoC cut interest rates, the banks most likely wouldn’t follow suit and lower prime rate. History backs this up – last time the overnight lending rate was cut, banks only cut prime rate by 10 to 15 basis points instead of the full 25 basis points.
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