Over the next several weeks, FCC Ag Economics will help you understand the rapidly evolving business environment due to COVID-19. With the costs to families continuing to climb and potentially unprecedented associated economic costs, central banks around the world are now working together to find ways to halt the damage.
In this post, I’ll explain several tools – both conventional and unconventional – the Bank of Canada (BoC) has available to mitigate the biggest economic risks facing Canadians today. Keep an eye on these in the weeks ahead. The government of Canada, which works independently of the Bank, is also helping with its own measures.
How interest rates can moderate a pandemic’s economic impacts
The economic damage from COVID-19 will include layoffs and supply chain disruptions, leading to expected declines in spending, business investment and exports. To slow this, banks use conventional tools to make it easier for households and businesses to access money and spend it. And an easy way to do that is lower interest rates. It brings immediate relief although it often takes over a year to feel the full effect.
Get comfortable with the following terms, so you can anticipate and respond to a quickly evolving interest rate environment.
Overnight rate: The rate banks charge each other on daily loans.
Policy rate: The BoC sets a target for the overnight rate used by financial institutions (FIs). This target is the policy rate. The BoC cut the policy interest rate from 1.25% to 0.75% on Friday, March 13, to help weaken the economic impact of the coronavirus outbreak and plummeting oil prices. Underscoring the threat posed by the disease outbreak, the cut was the second in just over a week.
Prime rate: The rate of interest commercial banks use to set the rate on variable loans and lines of credit. Each major financial institution (FI) has its own prime rate. When the policy rate changes, an FI can change its prime rate by a similar amount – although they don’t always do so.
Interest rates and you
Borrowers’ interest rates can also vary for other reasons. The rates you pay on variable rate loans will differ from your fixed-rate loans because an FI faces different risks with each fund source. When changes occur in financial markets – as is happening now – the rates charged to borrowers fluctuate.
There’s no correct answer as to which rate is better. Interest rates on variable-rate loans are stated as a percentage above or below the prime rate. How much above or below prime depends on your own borrowing situation, but that adjustment will be fixed for the loan term. The prime rate may subsequently vary.Click here to see more...