Why are interest rates increasing so rapidly?
If you own a house or have been thinking about buying, rising interest rates is a hot topic. The ‘interest rate’ in question is the Bank of Canada’s (BoC) policy interest rate, also known as the target overnight or benchmark interest rate. Changes in the BoC policy interest rate affects Prime Rate, which in turn sets the rates for variable (adjustable) mortgages and lines of credit (secured and unsecured).
Since the Bank of Canada is the sole issuer of Canadian banknotes, they essentially control the flow of money into the economy. The Bank of Canada’s prime goal it to keep inflation between 1-3%. The idea behind inflation is that prices increase in response to a larger supply of currency in circulation to purchase the same goods. By controlling exactly how much money enters circulation, the bank can help to control inflation.
By increasing the cost of borrowing money from the bank, they can reduce the overall demand for money. People tend to spend less and save more when interest rates are high, which reduces spending and helps to slow the rise of inflation in response.
Unfortunately with inflation being at record highs, this means we won’t see an end to the increased interest rates right away. The good news is that the economy works in a cycle. What goes up must come down! So while currently all you hear about is increasing rates, there will come a time when the BoC will need to stimulate spending and the floating policy interest rate will come down.