Interest rates can shape the financial lives of Canadians in powerful ways. Whether it’s the monthly cost of a mortgage or the return on a savings account, most interest rates can be traced back to one key figure: the Bank of Canada’s overnight lending rate. In recent years, this benchmark has moved beyond financial circles and become a more frequent topic in everyday conversations.
The overnight rate is more than just a policy tool. It’s central to how the Bank of Canada manages the country’s economic stability, keeps inflation in check, and supports sustainable growth. Understanding how it works – and why it matters – is essential to navigating today’s economic landscape, especially how it impacts Canadians’ ability to finance their homes.
TABLE OF CONTENTS
- What Is the overnight lending rate?
- How the overnight rate works
- Why the Bank of Canada changes the overnight rate
- The overnight rate and COVID-19
- Real-world impacts on consumers
- Lending rates and tariffs in today’s economy
What is the overnight lending rate?
The overnight lending rate – or key lending rate – is the interest rate at which major financial institutions borrow and lend funds among themselves. These transactions are typically very short-term – just one day (in other words, overnight) – and are used by banks to manage their day-to-day liquidity needs.
The Bank of Canada sets a target for this rate as part of its monetary policy strategy. This target forms the core of the Bank’s key policy interest rate and serves as a benchmark for virtually all other short-term interest rates in the economy. It directly influences the prime rate set by commercial banks, which in turn affect rates on variable mortgages, lines of credit, business loans and other financial products.
How the overnight lending rate works
The Bank of Canada does not simply declare an interest rate and expect markets to follow. Instead, it sets a target rate and operates within a framework known as the “operating band,” which is typically a 0.5 percentage point range. For example, if the target for the overnight rate is 5.0%, the upper limit of the band would be 5.25% and the lower limit would be 4.75%.
To ensure the overnight rate remains close to its target, the Bank of Canada uses open market operations – buying and selling government securities to manage the supply of money in the financial system. These operations help keep the actual rate that banks charge each other aligned with the target.
Why the Bank of Canada changes the overnight rate
The primary reason the Bank of Canada adjusts the overnight rate is to control inflation and stabilize the economy. Currently, the Bank has an inflation-control target of 2%, with a tolerance range of 1% to 3%. When inflation is running too high or too low, or when economic growth deviates significantly from potential, the Bank may alter the rate to guide the economy back toward balance.
- Raising the rate: When inflation is above target or the economy is overheating, the Bank raises the overnight rate. This makes borrowing more expensive and encourages saving, which tends to reduce consumer spending and investment. As demand slows, inflationary pressures begin to ease.
- Lowering the rate: When economic growth is weak or inflation falls below the target, the Bank lowers the rate. Cheaper borrowing encourages households and businesses to spend and invest, supporting growth and helping inflation return to target.
The Bank of Canada holds eight fixed policy rate announcements per year (twice per quarter), scheduled in advance. At these meetings, the Governing Council assesses current economic conditions and decides whether to raise, lower, or maintain the overnight rate. These decisions are based on a comprehensive analysis of inflation trends, GDP growth, employment data, consumer spending, business investment and global economic developments. While changes are most commonly made during these scheduled announcements, the Bank can also take action between meetings in extraordinary circumstances, such as during the 2008 financial crisis or the early months of the COVID-19 pandemic.
The overnight rate and COVID-19
The COVID-19 pandemic marked one of the most significant periods of monetary policy intervention in recent history. As the pandemic triggered an unprecedented economic shock in early 2020, the Bank of Canada acted swiftly to lower the overnight rate to stimulate the economy and cushion the financial blow to households and businesses.
At the onset of the pandemic, the Bank slashed its overnight rate from 1.75% to 0.25% in a series of large and rapid cuts. This level was considered the “effective lower bound,” a point at which the rate could not be realistically lowered further without distorting market functioning. The aim was clear: make borrowing as affordable as possible to support economic activity during a period of severe uncertainty.
As a result:
- Mortgage rates dropped to historic lows, spurring a boom in homebuying and refinancing.
- Lines of credit and variable-rate loans became significantly cheaper, providing relief for many households facing income disruption.
- Business loans were offered at more attractive rates, helping companies manage cash flow and avoid layoffs.
- Yields on savings accounts plummeted, prompting some investors to shift funds toward equities and other riskier assets in search of greater returns.
The low-rate environment persisted for much of the pandemic, helping to fuel strong consumer demand and support recovery. However, it also contributed to rising asset prices and created the conditions for inflationary pressures that would emerge more forcefully in the post-pandemic period.
This time in history highlighted the powerful role the overnight lending rate plays in an economic crisis, serving as a tool not just for economic stabilization but for shaping the pace and nature of recovery.
Real-world impacts on consumers
Although the overnight rate operates in the background of the financial system, its effects are very real for Canadians. Changes to the overnight rate cascade through the economy, shaping financial conditions at every level.
Borrowing costs
One of the most immediate effects of a rate change is seen in borrowing costs. Variable-rate mortgages and lines of credit are directly tied to the prime rate, which typically moves in lockstep with the overnight rate. A rate increase can translate to higher monthly payments for households carrying variable-rate debt. Conversely, rate cuts often bring relief to borrowers by lowering interest obligations.
Savings and investment returns
The overnight rate also influences the returns available on savings accounts, Guaranteed Investment Certificates (GICs), and other fixed-income products. Higher rates tend to improve returns for savers and conservative investors, while lower rates may push investors toward riskier assets in search of better yields.
Housing market dynamics
The real estate market is particularly sensitive to interest rate changes. Higher rates can cool housing demand by increasing the cost of borrowing, which in turn can moderate price growth. Lower rates can spur demand and put pressure on prices, especially in markets with limited housing supply.
Lending rates and tariffs in today’s economy
The Bank of Canada’s overnight rate currently stands at 2.75%, following a series of cuts that began in 2024. While rate reductions have provided some relief to borrowers, the central bank continues to face the intricate challenge of balancing inflation and navigating the economic impact of global trade uncertainties.
Consumers have benefited from more affordable borrowing costs over the past year, particularly for variable-rate mortgages and personal loans. However, with the path forward for monetary policy less certain, rate-sensitive borrowers may face a period of relative stability rather than continued easing.
Tariffs are a major economic concern in 2025. In recent months, renewed trade tensions – especially between Canada and the United States – have added complexity to the Bank of Canada’s policy outlook. New U.S. tariffs on Canadian steel, aluminum, and energy have prompted retaliatory measures from Canada, resulting in higher input costs for many businesses.
As the year progresses, the Bank’s challenge will be to balance domestic economic needs with the risks posed by international trade developments, all while maintaining inflation within its target range.
