Overnight Lending Rate in Canada

The Overnight Lending Rate in Canada is currently 3.25%. This rate, also referred to as the Bank of Canada’s policy interest rate, key interest rate, or target rate, is the benchmark cost of borrowing set by the central bank. This rate influences the Prime rate set by lenders for variable loans and lines of credit, including variable-rate mortgages and HELOCs.

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What is the Bank of Canada Overnight Rate?

The Bank of Canada’s Overnight Lending Rate is the main tool the central bank uses to set monetary policy; changing this rate can regulate the cost of borrowing and investment demand, which in turn influences the pace of inflation growth and helps keep the Canadian dollar stable.

The Bank of Canada states the direction for the Overnight Lending Rate in eight pre-scheduled announcements each year, indicating whether it will raise the rate, lower it, or hold it stable. The main purpose of setting this rate direction is to control inflation, which the central bank has a mandate to keep at a 2% target. When inflation falls below this level, the Bank of Canada will respond by cutting the Overnight Lending Rate, and will hike it when inflation surpasses this target.

What does overnight lending rate mean?

The rate is referred to as “overnight” because it actually sets the cost for Canada’s banks to borrow money from each other at the end of each business day. These institutions are constantly exchanging money over the course of the day in order to have the funds available to service their consumers. For example, any time a shopper uses their debit card or makes an e-transfer payment, money flows from one financial institution to another. The ability to move funds with ease – also known as liquidity – is a crucial part of Canada’s financial system, and underpins a healthy economy.

However, these institutions must settle their payments at the end of each day, as some will have lent out more than they brought in, and vice versa. They can do this by again borrowing money from each other in the overnight market, the cost of which is set by the central bank’s overnight lending rate (currently 3.25%).

If they choose, consumer banks can also borrow or deposit funds directly with the Bank of Canada in order to settle their balance sheets. The Bank offers both a deposit rate, which allows lenders to deposit funds overnight and earn interest, and a Bank rate, which is the cost for lenders to take out a one-day loan from the Bank. Today’s Bank Rate is 3.5% and the Deposit Rate is 3.25%, indicating an operating band of 0.25%.

While these interest rates do not directly affect consumers, they’re important behind-the-scene metrics that trickle down through the cost of all credit products. 

How does the Overnight Lending Rate affect mortgage rates in Canada?

WATCH: December 11, 2024 Bank of Canada announcement 

How does the Overnight Lending Rate impact variable mortgage rates in Canada?

The Bank of Canada’s Overnight Lending Rate is also used by consumer lenders to set the cost of their variable-rate borrowing products, including variable mortgages, lines of credit, and HELOCs, credit cards, auto loans, and more, via their Prime rate.

Lenders set their Prime rate based directly on the Bank of Canada’s Overnight Lending Rate, and will discount or increase Prime by the same amount whenever the central bank makes a change. This has an immediate effect on variable-based borrowing products, which are based on the Prime rate plus or minus a certain percentage. This means, if you have a variable rate mortgage, your mortgage rate will rise or fall alongside your lender’s Prime rate, which will move based on whatever the Bank of Canada has done to the overnight lending rate.

Let’s look at an example. If the prime rate is 6.7%, and you get a variable-rate mortgage at prime minus 1.15%, your effective interest rate will be 5.55%.

Example 1: Your original mortgage rate

prime rate - discount to prime rate = your mortgage rate

6.7% - 1.15% = 5.55% 

Now, let’s say the Prime rate increases by another 0.25% during your mortgage term to 6.95%.

Example 2: Your new rate after prime rate increases during your mortgage term

new prime rate - discount to prime rate = your new mortgage rate

6.95%  - 1.15% = 5.8% (new mortgage rate)

If your variable mortgage interest rate changes during your term, it will also impact your monthly mortgage payments.

If your variable mortgage has variable payments, the actual amount you’ll need to pay per month will increase immediately along with the prime and overnight lending rate. If you have fixed payments, however, a larger portion of your payment will then go toward interest, and less towards your principal mortgage balance. The opposite occurs when the BoC cuts its overnight lending rate; your monthly payments will decrease, or the amount going toward your principal balance will increase.

Because of these possible fluctuations, variable-rate mortgages are considered to have a higher risk profile than fixed-rate mortgages. However, borrowers are often given the option from their lender to convert their variable-rate mortgage to a fixed-rate mortgage at any time.

How does the Overnight Lending Rate impact fixed mortgage rates in Canada?

While the Bank of Canada’s overnight lending rate doesn’t directly dictate the fixed cost of borrowing in Canada, any rate hikes, cuts, or holds made by the central bank will influence fixed mortgage rates via the reaction in the bond market.

Lenders use five-year government bond prices to set the pricing for fixed mortgage rates, as bond yields directly impact their funding costs; when yields increase, so too will the price of fixed rates, and vice versa. Bond yields generally react to any movement made by the Bank of Canada as well as the rate of inflation. When the BoC cuts its rate, it is typically a signal that inflation is trending downward. Bond investors like this, because it increases the value of their holdings; as a result, more investors purchase bonds, which drives the yield down further.

On the other hand, a rate hike signals inflation has exceeded the BoC’s 2% target, and the higher interest rate environment then devalues existing bonds, which must then be sold at a discount to compete with newly issued investments. This attracts fewer investors, and yields rise higher, in turn increasing the costs for banks, which pass that down to consumers with higher fixed mortgage rates.

A historical look at the Overnight Lending Rate

The Bank of Canada has been playing an important role in regulating the Canadian economy since it was founded in 1935. Initially, the BoC set only the Bank rate – the cost of borrowing for one-day loans from the bank to consumer lenders. The Overnight Lending Rate was then introduced in 1996, when the BoC switched from a floating Bank Rate to one that was set at the top of its operating band. It began its policy for announcing its key rates in eight pre-scheduled announcements in 2000. 

→ Jump to Overnight Lending Rate vs. Prime Rate (2010 - 2024) 

Bank prime rates

• Tangerine Prime Rate 
• TD Bank Prime Rate 
• Scotiabank Prime Rate 
• HSBC Prime Rate 
• Bank of Montreal Prime Rate 
• CIBC Prime Rate 
• RBC Royal Bank Prime Rate 

Also read: 

• Prime Rate Canada
• Fixed vs. variable mortgage rates
• Bank of Canada hikes target interest rate to 5% in July announcement
• What's in store for Canadian home prices in 2023?
• How to tell if mortgage rates will go up or down

References:

1. Bank of Canada: Understanding our policy interest rate
2. Bank of Canada: Policy interest rate
3. Bank of Canada: A history of the key interest rate