As per Wowa; The Bank of Canada makes its decisions based on the growth of the Consumer Price Index (CPI), reported by Statistics Canada. CPI is calculated from the price of a “basket” of goods and services typically consumed by Canadians. It represents a broad picture of consumer spending across Canada.
Using its monetary policy tools, the Bank of Canada aims to maintain inflation, as calculated by changes in the CPI, within a certain range. Introduced in 1991, the inflation-control target sets a range of 1% – 3% as the ideal range for annual inflation, with the midpoint of 2% being the common target rate. This range is reviewed regularly with the latest review being in October 2016.
The Bank of Canada reviews its benchmark interest rate eight times a year and considers both local and international, current and potential influences in their review. Although the Bank of Canada operates independently of the government, it is ultimately responsible to Parliament through the Minister of Finance.
Think of the banks as a group of friends. The banks don’t like to hold cash and like to lend out their money whenever they can. Sometimes, Bank A might have a lot of cash on its hands while Bank B might have less. Since they’re friends, Bank A is more than happy to lend money to Bank B. But they’re banks, so they don’t want to lend their money out for free. So they charge an interest rate.
How the Overnight Rate Works
Every day, the banks come together and make offers to borrow and lend money. The rate that they settle on is called the “overnight rate” because it’s the interest rate for borrowing cash “overnight”. The Bank of Canada is the “mom” of the group. The Bank of Canada has a “target overnight rate” and tries to keep the overnight rate close to the target. If the rate gets too low because there’s too much money, the banks can lend their money to the Bank of Canada instead. If the rate gets too high because there’s a shortage of money, the Bank of Canada acts as a “lender of last resort” and will lend out money.