Understanding our policy interest rate

At the heart of the Bank of Canada’s monetary policy is the target for the overnight rate. See what it is—and what it means for you.

The target for the overnight rate

At the Bank of Canada, the primary tool we use to control inflation is our target for the overnight rate—also called our policy interest rate. This is the starting point for setting many of the interest rates in the economy that matter for Canadians.

The overnight market

Every business day, Canada’s financial institutions move money back and forth among themselves for their customers. Whenever you use your debit card or send an e-transfer, money flows between financial institutions. At the end of each day, they need to settle all these payments. Some institutions may have sent out more in payments than they received, while others may have received more than they sent.

To get back to balance, financial institutions can borrow money from each other for one day in the overnight market. The Bank sets a target for the interest rate we want financial institutions to charge each other when they make these overnight loans.

Deposit rate and bank rate

Financial institutions don’t have to borrow from each other to get back to daily balance—they can also use the Bank. They can deposit money with us at the deposit rate for one night or borrow money from us at the bank rate for one night.

The range between the deposit rate and the bank rate—called our operating band—is usually one-half of a percentage point wide, with our policy interest rate sitting in the centre. For example, if the Bank sets the policy interest rate at 2.25 percent:

  • The lower end of the range is 2 percent—our deposit rate.
  • The higher end of the range is 2.5 percent—our bank rate.

How this actually works

In reality, financial institutions almost always choose to borrow and lend among themselves. This is because the whole system always balances. An institution that needs money knows there is another institution with extra money to lend.

The difference between the deposit rate and the bank rate encourages financial institutions to do this borrowing and lending with each other instead of coming to us. For example:

  • Bank A has extra money. It can earn more interest by lending that money to Bank B than by leaving it with us and earning the deposit rate.
  • At the same time, Bank B needs money. It would rather borrow at a lower rate than at our bank rate. So, it’s better for Bank B to borrow from Bank A.

This gives a powerful incentive for banks to borrow and lend within this band. When we adjust our policy interest rate, we also adjust the deposit rate and the bank rate by the same amount to maintain the operating band.

In response to the 2007–09 global financial crisis and again in 2020 during the COVID-19 pandemic, the Bank cut the policy interest rate to 0.25 percent to support the economy. With the rate at this level, the Bank temporarily set the deposit rate at the same level as the policy interest rate, resulting in an operating band of 0.25 percent to 0.50 percent.

What it all means for you

The public doesn’t access this overnight market to borrow or lend money. Still, our policy rate and this market are important to you. By encouraging financial institutions to borrow and lend among themselves at close to the policy rate, the Bank affects interest rates on all kinds of other borrowing in the economy, including:

  • the prime rate of commercial banks (used for loans such as lines of credit)
  • mortgage rates
  • interest rates paid on deposits, guaranteed investment certificates and other savings

Why we change the target

If the economy is struggling to grow, it could pull inflation significantly below 2 percent. In response, we might lower the policy rate so that other interest rates across the economy go down. This means:

  • People and businesses pay lower interest on loans and mortgages and earn less interest on savings.
  • With lower rates, people tend to spend more, boosting the economy.

But if the economy is growing too fast, it could lead to rising inflation. So, we might raise the policy rate, which means:

  • People and businesses pay higher interest on loans and mortgages. This discourages them from borrowing, reduces their spending and puts the brakes on inflation.
  • With higher rates, people tend to save more and spend less, slowing down the economy.
In 2000, the Bank introduced a schedule of eight fixed dates per year for announcing the policy interest rate. In special circumstances, we may announce rate changes at other times—for example, on March 13, 2020, and March 27, 2020, in response to economic shocks from the COVID-19 pandemic.
Content Type(s): Explainers
Topic(s): Monetary policy