The Bank of Canada Lowered the Overnight Rate – Now What?

The Bank of Canada lowered the Overnight Rate to 2.50% on Wednesday, down 25 basis points from July and the first cut since March. The economic implications of this are mixed; however, it’s important to understand how the Governors of the Bank of Canada came to this decision. What is the Bank of Canada, what role do they play in the Canadian economy, and what does this interest rate cut actually mean to the average Canadian?

Founded in 1935, the Bank of Canada (BoC) was created as a means of organizing our national banking system in response to the prolonged economic slump of the Great Depression. Initially it was privately owned with shares sold to the public, however it became a publicly-owned in 1938 and remains so today.

The BoC operates under the framework of the Bank of Canada Act. Although the Act has been amended many times over the years, the preamble has never changed – that the BoC exists to regulate credit and currency in the best interests of the economic life of Canada and Canadians. 

Among its key responsibilities:

• Monetary policy: It uses tools (chief among them the policy target for the Overnight Rate) to influence inflation, economic growth, and financial stability;
  
  
• Inflation control: Its formal inflation-targeting mandate is to keep inflation in a range, typically 1%–3%, aiming for about 2%. When inflation is too high, it raises rates; when inflation is too low (or the economy is weak or weakening), it lowers rates;
  
  
• Financial system oversight: It works to ensure the banking/financial system is safe, liquid, efficient; and
  
  
• Maintaining the value of money: This includes issuing currency, managing exchange rate risks indirectly, and ensuring trust in the money supply.
  
  

What is the Overnight Rate?

The Overnight Rate (also called the policy interest rate) is the interest rate that major financial institutions charge each other for very short-term (overnight) loans. BoC sets a target for that rate.

It is the anchor for many other rates in the economy:

• The prime rate often tracks off of it;
• Variable-rate mortgages, lines of credit, business loans, and credit card rates are influenced; and
• The rates financial institutions offer savers (savings accounts, GICs etc.) generally also respond (though often more slowly) to changes in the Overnight Rate.

The BoC has a schedule of eight fixed dates per year for announcing the Overnight Rate. For example, the next announcement will be on October 29.

Factors that Affect Decisions on the Overnight Rate

When the BoC’s Governing Council decides whether to raise, lower, or maintain the Overnight Rate, they consider many pieces of information. Key factors include:

1. Inflation trends
   • Where the inflation rate is (based on the Consumer Price Index), but also core measures (excluding volatile items like food and energy).
   • Whether inflation is projected to stay in BoC’s target range of 1%-3%.

2. Economic growth (GDP, business investment, exports etc.)
   • If growth is slowing (or if the economy is contracting), BoC may lower rates to stimulate growth to help avoid a recession.
   • If the market is overheating (too much demand), raising rates helps cool things.

3. Labour market conditions
   • Growth in the unemployment rate – or a softening of the labour market - could lead to an Overnight Rate decrease.

4. External / global factors
   • Trade and tariffs impact the strength of the economy and could impact the BoC’s decision
   • What other central banks are doing and foreign financial market conditions may also be considered.

5. Forward guidance and market expectations
   • How future inflation and growth is expected to evolve can influence the BoC’s decision.
   • The BoC wants its decisions to align with market projections so business and consumers can plan.

What Lowering the Rate to 2.50% Means to Canadians

Here’s how rate-cuts generally flow through, and what people might see:

In terms of Wednesday’s announcement, the Overnight Rate has been cut to 2.50% which is the lowest rate in about 3 years. In a press conference, Tiff Macklem, the Governor of the Bank of Canada, cited the weakening labour market, slower GDP (mostly due to US tariffs), and the diminished inflation risk as the reason for the rate cut.

While this is welcome news to those Canadians who carry debt, the rate cut does come with some trade-offs.

Possible Downsides / Things to Watch:

• Savings lose return: Those who depend on interest income may earn less interest;

• Inflation could creep up if demand picks up strongly, especially for housing or other constrained sectors;

• Longer-term fixed mortgage rates might not fall immediately, or as much. Markets set them based on expectations, credit risk, and inflation; and

• Debt risk: Lower rates can encourage more borrowing; if incomes stagnate or inflation rises, those debts can become harder to service.

The Bottom Line:

For typical Canadians who are working, spending, saving, and living, this is what you’re likely to see:

• Your payments on a variable-rate mortgage or line of credit may drop, giving you some breathing room in monthly budgeting.
  
  
• If you’re looking to buy a home or start a project (home reno, business investment), the cost of financing may be more favourable now.
  
  
• If you have savings, your interest earnings might be lower.
  
  
• Prices on things that are imported might go up a bit if the Canadian dollar weakens.
  
  
• Over time, the economy might pick up (more jobs, more business confidence), which could help job opportunities and wages, though it might take time and is not guaranteed.

If you have questions about interest rates, or your personal financial plan, meet with a member of our Kindred team to discuss your borrowing, savings, or investment needs.