Understanding the Overnight Interest Rate: Impact on the Economy

Overnight rate might sound like the five-dollars-more alternative to the hourly rate for the least reputable hotel in town, but in fact it’s a number that has a profound effect on a country’s entire economy. The overnight rate — often referred to as the key policy interest rate — is the interest rate banks charge one another to borrow money in order to maintain federally mandated cash reserve requirements.

The importance of this money to the economy can’t be overstated; it’s the gasoline that fuels the economy’s engine. Unlike, say, mortgage rates, banks have absolutely no control of the overnight rate. It’s dictated by the Bank of Canada’s Governing Council, the six-member body that meets eight times a year and decides if it wants to raise, lower, or keep unchanged the rate. (Whenever you hear breathless speculation in financial circles about whether the Bank of Canada will raise or lower interest rates, it’s shorthand for this process.) Any change in the overnight rate will have seismic effects in the economy. A lowering of the rate, undertaken in order to goose a sluggish economy, frees up the spigot of money by making interest rates in all manner of loans cheaper. Businesses expand, homebuyers buy, and stock markets generally rise.

Conversely, a rate hike — which turns down the flow of money through the economy to prevent inflation — generally slows things down, and depresses the stock prices of most publicly traded companies. Banks, who can rake in more revenue by collecting higher interest rates on loans, are one of the few exceptions.