3 min read

Bank of Canada raises interest rates

Written By

Clay Shiffman

Rounding it up

  • The Bank of Canada hiked its key overnight rate to 3.75% on October 26th, 2022

  • The bank has warned that it may need to rise rates further to combat inflation

  • Interest is the price you pay to borrow money

  • When interest rates rise, monthly loan payments become more expensive

If you haven’t already heard, or maybe you’re just pretending you didn’t, on October 26th, 2022, the Bank of Canada announced that it would raise the benchmark interest rate by 50 basis points, bringing it up to a whopping 3.75%. The year began with the rate at 0.25%, following a trio of rate cuts in the early days of the pandemic that was intended to stimulate the economy. This serves as a clear message that the Bank of Canada is continuing to take a tough stance on inflation.

The Bank of Canada has warned that interest rates may need to rise even more, most likely again on December 7th, in its continued fight against inflation.

Wait, what are interest rates really for?

If you're still confused about interest rates, don't worry, you're not alone – we've all heard of them, but really, what are they?

Interest is the price you pay to borrow money. When you take out a loan, the bank charges you for the privilege of using their money by taking a certain percentage of the outstanding loan back—that's the interest rate. The percentage that's paid back is usually stated as an annual amount, so when it comes to calculating monthly payments on loans and credit cards, be sure to divide that number by 12.

Interest rates vary widely depending on what type of loan or line of credit you're looking at and the institution that's offering it. The more risk lenders take on in giving you a loan, the higher the interest rate will be. For example, if you have a low credit score, your interest rate will be higher. Also, interest rates are higher for longer-term loans, because lenders are taking on the risk of future economic conditions.

When interest rates go up, people save more and borrow less. This reduces the amount of money flowing through the economy, which helps lower inflation because companies have to lower their prices to encourage more demand.

The Bank of Canada often increases or decreases interest rates for three main reasons:

Supply and demand - if there is a strong demand for access to loans or lines of credit, but not enough immediate availability of these funds, the Bank of Canada will raise interest rates and keep them high. Alternatively, if there are many loans or credit lines available, the interest rate will be lower because the supply is greater than the demand.

Economic Stagnation - If there isn’t enough money moving through the economy, the Bank of Canada will typically lower interest rates to stimulate economic activity, this was the case during the pandemic. As a result, banks will be more likely to lend funds to consumers, who will then have more money to make purchases and contribute to the economy.

Inflation - As mentioned above, high inflation rates are usually tied to an increase in interest rates as a measure to cool the economy and force companies to slow their price raising. As a result of this period of high inflation, the Bank of Canada has continuously hiked interest rates to try and combat rising prices.

What does the Bank of Canada’s interest rate announcement mean for Canadians?

Simply put, a rise in interest rates from the Bank of Canada means it costs Canadians more to borrow money. If you have a loan or mortgage with a variable rate on a car or home, for example, your monthly payments are going to go up. For some, this rise in payment costs might be too much to handle and may force people to sell their cars or homes.

A small increase in mortgage rates may seem insignificant, but it can still add hundreds of dollars to your monthly payments.For many Canadians, that can be an unaffordable amount of money, especially when inflation is high and the economy is slowing down.

As a response to the Bank of Canada raising its rates, we’ve seen Canada’s biggest banks raise their prime lending rates by the same amount the central bank has.

On the flip side, the continuing rise in interest rates might finally begin to start cooling off the red hot inflation that has affected all of us, hopefully giving Canadians some of their purchasing power back.

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