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What is the target overnight rate?
The target overnight rate is a key Bank of Canada-controlled interest rate used as a basis for one-day (or "overnight") borrowing between the major lenders and financial institutions. This rate plays a pivotal role in influencing the economy.
The pivotal role played by the Bank of Canada's target overnight rate
The target overnight rate is the primary monetary policy instrument available to the Bank of Canada. By changing the overnight rate, the Bank of Canada can assert short-term control on the demand and availability of credit products across the board. This control causes a delayed, but direct, effect on the level of inflation of the Canadian dollar.
When the overnight rate is decreased, the cost of credit decreases, mortgage rates fall, and consumer demand for credit products rises. In situations where the overnight rate has fallen, it also becomes easier for banks and lending institutions to provide credit for consumers because it's less expensive for them to lend amongst themselves.
The opposite is also true, that in increasing the overnight rate, the cost of credit increases, and, temporarily, demand sinks.
Last reported target overnight rate was:0.25%*
* April 2020 - The central bank made the rate announcement as part of a package of measures announced by the federal government in response to COVID-19 (Coronavirus).
The Bank of Canada's monetary policy and focus on inflation
The primary role of the Bank of Canada is to contribute to a healthy Canadian economy. It has been well established since the 1970s (Milton Friedman, et al) that high rates of inflation cause uncertainty in the market, and in the long-run, damage. As a result, one of the primary goals of the Bank of Canada is to keep inflation at a minimum level.
The short- and long-term effects of target overnight rate changes
In the short-term, decreasing the overnight rate can be done to influence many important economic elements. Among these economic elements are the unemployment rate, income levels, and the rate of market growth. In the long-term, however, effects from changing the overnight rate are overcome by market adjustments in wages due to excess demand or supply. Moreover, keeping the overnight rate low increases the rate of inflation.
All things being equal, increasing the overnight rate makes Canadian investment products more attractive to foreign investment firms, increasing demand for the Canadian dollar, thereby increasing its relative value. A higher Canadian dollar makes foreign goods less expensive, quelling domestic inflationary pressures. In the long-term, this has a positive effect on the economy.
The Bank of Canada's policy on the value of the overnight rate
Since December of 2000, the Bank of Canada has instituted a system of changing the target for the overnight rate on only eight pre-announced days per year. As a matter of policy, the Bank of Canada attempts to keep the overnight rate within a target range of 1% to 3%.
Since the beginning of 2009, the overnight rate in Canada has been relatively low. January of 2009 saw the overnight rate at 1.00%. In a matter of 3-5 months, this rate quickly dropped in response to the worldwide credit crisis and we witnessed the lowest overnight rate in recent history. By the last quarter of 2009, the overnight rate dropped to an unprecedented 0.25%. The overnight has since returned to 1.00% and stayed steady since then.