Last Updated: December 6, 2023
The Bank of Canada is a crown corporation that serves as the country’s central bank. It was established in 1934 by the Bank of Canada Act and is responsible for monetary policy and financial system regulation in Canada. Its primary mission is to “promote Canada’s economic and financial well-being.” Its principal tool for implementing monetary policy, led by a governing council, is the overnight rate target also known as the key policy rate. By adjusting this rate, it is possible to influence the supply of money circulating in the Canadian economy. It is also entirely responsible for Canadian currency issuance and distribution, as well as the control of foreign currency reserves.
The Bank of Canada was founded as Canada’s central bank in 1934 and opened their doors and began operations, following the granting of royal assent to the Bank of Canada Act in March 1935. The Bank of Canada was privately owned at first, but became majority owned by the federal government in 1936 and fully nationalized in 1938. The main purpose of the Bank of Canada was “to regulate credit and currency in the best interests of the economic life of the nation, to control and protect the external value of the national monetary unit and to mitigate by its influence fluctuations in the general level of production, trade, prices and employment, so far as may be possible within the scope of monetary action, and generally to promote the economic and financial welfare of the Dominion”.
In 1935, the Bank of Canada rate started at 2.50% and by 1945 it was at 1.50%. Canada played a vital role in supplying natural and manufactured resources to the Allies which helped the economy strengthen during the war. Employment of women also increased and the drop in the Bank rate encouraged people and businesses to borrow money to invest in new manufacturing plants and housing. After World War II, the Bank of Canada rate didn’t rise until October 1955 to 2.00%. This promoted investment in infrastructure, manufacturing, housing and consumer goods. When inflation began to rise in the early 1960s, then-Governor James Coyne ordered a reduction in the Canadian money supply.
After the rate raise in 1955, the Bank of Canada rate continued to rise throughout the 1960s and early 1970s. The benchmark rate hit double digits for the first time at 10.25% in October 1978. In August 1980, oil prices hit a record high and the Bank of Canada hit an all time high of 20.03% in August 1981.
After the 1980s recession, the Bank of Canada rate went downwards between 1991-2009. The inflation target rate was introduced at the beginning of this period.
Following the 2008 recession, the central Bank of Canada lowered interest rates to stimulate the economy and for the first time ever, the rate dipped below 1% to 0.5% in March 2009. There was a minor recovery in 2014 however oil prices dropped 60% which caused a recession in Canada’s export economy. In 2015, the Bank of Canada rate then dropped from 1.25% to 0.75%.
By the end of 2018, the Bank of Canada had raised rates up to 1.75% from a low of 0.5% in May 2017 in response to economic growth, and rates remained at 1.75% for the duration of 2019. COVID-19 impacts cause two 50 basis point drops in March 2020 where the rate was at 0.25% for two years to mitigate the effect of the pandemic on the economy. This was then followed by quantitative easing, where the Central Bank increased the money supply to create funds for government spending, but this led to the inflation rate reaching the highest it’s ever been in over 30 years at 4.80%. The Central Bank stopped its practice of quantitative easing by October 2021, and accelerated the timeline of increasing interest rates to pre-pandemic levels. The expansionary monetary and fiscal policy caused inflation and forced the BoC to start increasing rates in early 2022.
The Bank of Canada influences the interest rate for all borrowing and lending transactions in Canada through the key policy rate and other monetary policy measures. Changes in the key policy rate generally result in changes in bank Prime rates, which means the main policy rate has a major impact on variable mortgage rates based on a lender’s Prime rate.
Changes in the key policy rate and monetary policy can have an impact on fixed mortgage rates as well. Fixed mortgage rates typically track the yields on 5-year Government of Canada bonds. A change in monetary policy can cause changes in bond yields, which can then cause changes in fixed mortgage rates.
To better determine the mortgage rate forecast, it’s important to take into account historical trends. During the great recession in 2008, the economy was able to get back on track after requiring bailouts and stimulus to keep running. There was very low GDP growth for over 10 years after the 2008 recession, which resulted in low interest rates. From 2020 – 2023 there was a similar economic bailout due to covid. However, this time the stimulus was far greater, with over 40% of dollars ever created between 2020 – 2022. As a result of the shutdown of the economy and supply chains, difficulty restarting these supply chains as well as the war in Ukraine, inflation is significantly more as the economy stabilizes.
Historical trends show that significant new government debt combined with already massive debt can lead to dependence on even more cheap debt to stimulate the economy. This can lead to long term economic stagnation and an amplified effect of increased rates. There is five times more debt in the economy today, adjusted to inflation than in the 80’s and 90’s, so a 0.25% rate increase can make a much more significant impact compared to when debt levels were a fraction of what our levels are currently. When rates increased from 10% to 20% in the 1980s, this was a 2x rate increase. However, when rates increased from 0.25% to 4.50% in 2022-2023, this was actually a 16x rate increase which will impact the economy significantly more.
A bank’s balance sheet shows that total assets equal total liabilities plus equity capital. The Bank of Canada has a zero book value policy on its balance sheet, matching total assets to total liabilities, and transfers any equity above this amount as a dividend to the Government of Canada.
The main roles of the Bank of Canada are:
Tiff Macklem was named Governor of the Bank of Canada for a seven-year term beginning June 3, 2020. As Governor, he also serves as Chair of the Bank’s Board of Directors and as a member of the Bank for International Settlements’ Board of Directors. He chairs the Group of Governors and Heads of Supervision, the Basel Committee on Banking Supervision’s monitoring body, and co-chairs the Financial Stability Board’s Regional Consultative Group for the Americas.