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In Canada, the prime interest rate varies and affects a number of factors, including mortgage rates and other lending rates. This impacts what Canadians purchase and how much of it is. The interest rate is factored into financing rates and can affect how much Canadians can afford. With the recent rate cut in Canada, we are going to see many Canadians' payments affected. Let’s take a look at how.
What It Means When Interest Rates Go Down
When the Bank of Canada lowers the prime interest rates, this means that Canadian banks are also allowed to lower their bank rates. That said, they don’t have to since they set their own lending rates. It’s their discretion as to when they can make this decision; however, in the past, the banks generally followed suit within a day.
It’s important to remember that the benchmark rate is just the rate that the Bank of Canada charges. Financial institutions will charge a little more than the prime rate. While this ranges, the bank's interest is usually around 2% more.
Once the banks change their rates to follow the prime rate, not all of those with financing are affected. Those with locked-in interest rates won’t have any changes in how much savings they earn. However, it will impact variable-rate loans. This is good for those who owe money. On the other hand, those with savings accounts earning interest, except for Guaranteed Investment Certificates, will see a negative impact.
Things That Become Cheaper With A Rate Cut
When a rate cut happens, the thing it affects the most is financing rates which reduce borrowing costs. Those with variable-rate mortgages will see a payment difference as well as those who have lines of credit. This is because all lines of credit have variable rate interest.
While the Bank of Canada’s rate cut can affect some current consumer loans, it also affects future financing. When the Bank of Canada policy rate lowers, auto loans and overall personal loan rates will become cheaper.
Things That Become More Expensive With A Rate Cut
While most things become cheaper when a policy interest rate cuts happen, one thing that will actually increase is bond prices. The bond markets have an interesting relationship with interest rates due to how they’re set up. When interest rates are high, bonds are cheaper. As interest rates start to drop, bond prices actually increase.
How A Rate Cut Affects Mortgages
When we think of interest rates, the most common thing that comes to mind is mortgages. In Canada, there are two different ways to finance your mortgage. This can be done with fixed-rate mortgages and variable-rate mortgages. How interest rates work is based on which type of mortgage that you have.
If you have a fixed mortgage rate, you’re locked into that mortgage for however many years that the financial institution is offering. Fixed rates won’t change at all until you renew. However, if you have a variable-rate mortgage, your interest rate is based on Canada’s prime rate. This means that your rate can change at any time during your mortgage term.
With a variable-rate mortgage, your payment may or may not be affected when an interest rate cut is made. It all depends on how your mortgage is set up. With some variable mortgage rates, your principal payment stays the same throughout the term. This means that your payments will increase in order to cover your interest payments. With other mortgages, the payments that you make throughout your mortgage term will stay the same, but how much interest is paid from your monthly payment will change.
An overnight rate cut can also affect mortgages by attracting prospective buyers. With lower borrowing costs as well as lower monthly mortgage payments, credit unions, digital banks and other financial institutions may see an increase in mortgage applications. While housing affordability is still high in Canada, a reduction in key interest rates through monetary policy could allow more Canadians to purchase a home.
How Rate Cuts Affect Stocks
When the Bank of Canada cuts interest rates, it affects more than just financing. Rate cuts can also impact the stock market. This is because the effect that interest rates have on stocks is similar to that of bonds. As interest rates increase, stock prices tend to go down, but when they decrease, stock prices go up. For those who invest in stocks, this is a good thing.
However, it’s important to keep in mind that this isn’t a hard and fast rule. This is just a generalization and one of many different factors that affect the price of stocks. Each stock's individual factors will also play a part in its pricing.
How Rate Cuts Affect Savings and Investments
When it comes to interest rates, savings and investments do better when they’re higher. This is because you earn more on your money with higher savings rates. Canadians also tend to invest more money when savings account rates are higher due to the fact that it’s a much more expensive time to purchase or take out financing.
When rate cuts happen, those with investments will start earning less in investment income. When the rate cuts are small, though, you can still earn decent interest. However, it’s important to remember when investing that rates are going to fluctuate all the time, and the longer you keep your investment, the better results you’re likely to see.
Rate Cuts and Inflation
Inflation and rate cuts in Canada are directly correlated. This is because the Bank of Canada uses the prime rate to influence the rate of inflation and keep it at a steady rate of between 2% and 3%. When inflation rates go significantly higher than the standard, interest rates are increased to lower the inflation rate. Once the inflation rate has lowered to where it should be, then rates are cut in order to keep inflation at that rate.
Currently, inflation rates in Canada are around 3%. However, the inflation outlook remains to be around 2% by the end of 2024. With inflation expectations sitting where they should be, this is good news. By sometime in 2025, the prime rate in Canada could be reduced by a full percentage point.
Recent Rate Cuts in Canada
Rate cuts in Canada happen at the discretion of the Bank of Canada. Until recently the last rate cut was in March of 2020. However, now that inflation has started to stabilize and there have been no more rising rates, the BoC has now made a rate cut. As of June 2024, the prime rate in Canada has a quarter percentage point cut to a 4.75 percent interest rate. While it’s unknown what any future rate cuts will be, it’s predicted that bank prime rates will be around 4.25% by the end of 2024.
Final Thoughts
In Canada, the Bank of Canada’s prime rate has a huge influence on the economy. It has an impact on investments, financing rates, wage growth, core inflation, and the Canadian housing market. These rate cuts will affect everyone differently, but keeping the rate of inflation stabilized will make a big difference in how much Canadians spend on their living expenses and everyday expenses.
