Over the years, the Bank of Canada has adjusted the way it sets its key interest rate. Following is a brief history of the key rate from the Bank's founding in 1935 until the present.
The original key interest rate was the Bank Rate. This is the minimum rate of interest that the Bank of Canada charges on one-day loans to financial institutions. Between March 1935 and November 1956, the Bank Rate was fixed, set directly by the Bank.
The Bank Rate became a floating rate, set at 25 basis points above the average yield on 3-month treasury bills at the federal government's weekly auction.
The Bank Rate was again fixed, set directly by the Bank.
The Bank Rate was returned to a floating rate, set at 25 basis points above the average yield on 3-month treasury bills at the federal government's weekly auction.
Since 1996 the Bank Rate has been set by the Bank at the top of its operating band for the overnight rate (see next column.) This provides a clearer indicator of monetary policy intentions, because the Bank's influence on the overnight rate is more direct than on 3-month treasury bill rates.
In December 2000, the Bank began setting the level of the Bank Rate—and with it, the target for the overnight rate—on eight fixed dates per year.
As of June 1994, the Bank began shifting emphasis from the Bank Rate to the target for the overnight rate as its key monetary policy instrument.
This shift followed the Bank's introduction of a 50-basis-point "operating band" for the overnight rate, which is the rate at which major participants in the money market borrow and lend one-day (or overnight) funds among themselves.
At that time, the Bank used daily adjustments in the level of settlement balances to set a "target level" for the overnight rate within the operating band. Specifically, the Bank would intervene with PRA and SPRA when the overnight rate hit the top or bottom of the operating band.
With the advent of the Large Value Transfer System (LVTS) in February 1999, the target for the overnight rate was defined as the midpoint of the band, or 25 basis points below the Bank Rate.
The shift in emphasis towards the target for the overnight rate was clearly communicated to the markets with the launch of the LVTS. However, it was not until 29 May 2001 that the Bank began emphasizing the target as its key interest rate in its communications with the public.
Because the target affects the interest rates that financial institutions charge each other from day to day, it usually affects other interest rates, such as mortgages and consumer loans.
The target for the overnight rate is also the most appropriate policy rate for international comparisons: for example, with the target for the federal funds rate in the United States and with the two-week repo rate in the United Kingdom.