Canada’s overnight interest rate and its impact on CAD

Canada’s overnight interest rate is a key interest rate indicator used by the Bank of Canada to influence the overnight lending rate in the Canadian financial system. It represents the interest rate at which large financial institutions borrow and lend money for a day among themselves. The Bank of Canada sets a target for this rate, which serves as a benchmark for other interest rates in the economy. Changes in the overnight interest rate can have significant impacts on borrowing and lending rates throughout the economy, affecting on consumer borrowing costs, business investment decisions, and general economic activity.

The release of Canada’s overnight interest rate index can significantly affect the value of the Canadian dollar (CAD). The reason for this is that Canada’s overnight interest rate index reflects the interest rate charged by the Bank of Canada on loans it provides to commercial banks in Canada overnight.

If the overnight interest rate increases, it means an increase in the cost of borrowing for banks, making it more than the interest rate you pay for Canadian dollars. Thus, increasing the overnight interest rate can reduce the possibility of borrowing and stimulate demand for the Canadian dollar, raising its value..

On the flip side, if the Bank of Canada lowers the interest rate, this reduces the attractiveness of the Canadian dollar as an investment currency, because the expected returns on CAD investments will fall. Thus, the value of the Canadian dollar may depreciate against other currencies.

In addition, if there are strong expectations regarding overnight rate changes, this could affect the trading of the Canadian dollar before the actual data is released, as investors and traders can adjust to the future expectations of monetary policy.

Bank of Canada’s forecast analysis: economic growth and inflation forecasts for the current year

In April, the Bank of Canada maintained its overnight rate target at 5%, along with the bank’s rate at 5% and a quarter deposit rate at 5%. The Bank remained steadfast in its commitment to quantitative tightening policies.

With global economic expansion expected to continue at around 3 percent, the bank expects inflation to gradually decline in most advanced economies. The resilience of the US economy exceeded initial expectations, supported by strong consumption and large investments from the private and public sectors. While US GDP growth is expected to slow in the latter half of the year, it is expected to beat the previous forecast released in January.

Conversely, the eurozone is poised to gradually recover from the current weak growth situation. Global oil prices rose slightly, beating expectations in the January monetary policy report by about $5. Since the beginning of the year, there has been a rise in bond yields; however, this has been accompanied by tightening corporate credit margins and a marked rise in stock market performance, which has eased overall financial conditions.

The bank has updated its forecast for global GDP expansion, forecasting a rise of 2% in 2024 and growth of almost 3% for 2025 and 2026. While inflation is slowing in most advanced economies, the next journey could be volatile. However, there is optimism that inflation will be in line with the central bank’s targets by 2025.

In Canada, economic momentum stalled in the latter part of the previous year, leading to increased supply in the market. Various metrics indicate continuous improvements in labor market dynamics. Although employment lagged behind working-age population growth, unemployment rose slightly, recording 6.1% in March. Encouragingly, recent signs point to a moderation in wage pressures.

The Bank’s GDP Forecast and Measures to Combat Inflation

Overall, the Bank expects GDP growth of 1.5% in 2024, 2.2% in 2025, and 1.9% in 2026. The booster economy will gradually absorb excess supply until 2025 and into 2026.

CPI inflation slowed to 2.8% in February, as broader price pressures across goods and services eased. However, home price inflation remains very high, driven by growth in rental costs and mortgage interest. Core inflation measures, which were around 3.5%, slowed to just over 3% in February, and three-month annual rates point to bearish momentum. The bank expects the CPI inflation rate to approach 3% in the first half of this year, move below 2.5% in the second half, and reach the 2% inflation target in 2025.

Based on expectations, the Board of Governors decided to keep the interest rate at 5% and continue to normalize the bank’s balance sheet. While inflation remains very high and risks remain, the CPI and core inflation have seen a further decline in recent months. The Board will look for evidence of the continuation of this downward momentum. In particular, the Board monitors the evolution of core inflation and continues to focus on the economy’s demand-supply balance, inflation expectations, wage growth, and corporate pricing behavior. The bank remains firm in its commitment to restoring price stability to Canadians.

The nightly interest rate index can affect the inflation rate in Canada. If the Bank of Canada increases overnight interest to control inflation, it may reduce borrowing and spending activity, reducing demand for goods and services, and thus can reduce inflation pressure.