Bank of Canada interest rate: how high can the prime rate go?

As part of its quantitative tightening plan to bring the inflation rate in Canada down to 2%, the Bank of Canada recently increased its key interest rate by 50 basis points (0.50%).

In response, nearly all major banks and lenders in Canada adjusted their prime rates accordingly, raising interest rates across the board.

This is the seventh consecutive increase in the Bank of Canada’s target for the overnight rate in 2022, and many Canadians are wondering how high Canada’s prime rate can go.

Today I’ll explain a bit more about what the prime rate is, how it can affect your personal finances, and provide some projections based on historical prime rate data.

WHAT IS THE CURRENT PREMIUM RATE IN CANADA?

On December 7, 2022, the Bank of Canada increased the target for the overnight rate from 3.75% to 4.25%. This 50 basis point hike imposed by the Bank of Canada took the Canadian prime rate from 5.95% to 6.45%.

Over the past year, Canadians have had to deal with rising interest rates as the government tried to control the rate of inflation. As the Bank of Canada increases its rates, the prime rate set by banking institutions also increases.

POLITICAL INTEREST RATE BoC VS. BANK PREMIUM RATE

It is important to understand the difference between the Bank of Canada’s key interest rate and the prime rate set by banks and lenders. Although the two rates are closely correlated, they are also different.

The Bank of Canada is the country’s central bank. Commercial banks such as RBC, TD Bank and others all borrow money from the central bank to balance their cash reserves. Whenever banks borrow money from the central bank, the funds are subject to the Bank of Canada’s key interest rate (also known as the target overnight rate).

Of course, commercial banks must also make a profit. Thus, commercial banks set their prime rate 2 to 3% above the central bank’s key rate. This is why the current prime rate set by banks is 6.45%, while the central bank’s policy rate is 4.25%.

How high can the prime rate go?

As the Bank of Canada’s policy rate rises or falls, the prime rate charged by the banks will be adjusted accordingly. Since March 17, 2020, the prime rate has steadily increased from its low point of 2.95% to the current prime rate of 6.45%. According to Wowa’s historical prime rate chart, the last time the prime rate was this high was in April 2001.

But how high can Canada’s prime rate go? Canadians could see even more prime rate increases in 2023.

In November, RBC predicted the most recent 50 basis point increase in the prime rate. The same report also predicts that the central bank will continue to raise its key rate by 25 to 50 points at each meeting. However, this projection also predicts that interest rate hikes may start to subside by March or April.

According to this projection, Canadians could see the prime rate increase to 6.95% (and possibly more) in early 2023.

That being said, these projections are purely hypothetical, as they are based on multiple economic factors. In the worst case, we can turn to historical data. The highest prime rate in Canadian history was 22.75% in August 1981. It would be devastating for many families if prime rates were to reach such high levels today.

Hopefully things won’t be so bad, as the Canadian job market still looks pretty solid. The government’s monetary policy of all these rate hikes could keep inflation under control and eliminate the need to keep raising overnight rates. The Bank of Canada has also hinted that it may suspend rate hikes next year.

WHY IS THE BANK OF CANADA INCREASE ITS KEY RATE?

Although inflation is down from its peak of 8.1% in June 2022, it is still at an all-time high. According to the latest data from Statistics Canada, the consumer price index (inflation rate) in Canada is currently at 6.9%.

One of the main reasons why the central bank raises its key rate (thereby leading to an increase in the prime rate) is to fight inflation. When interest rates are higher, there is less liquidity in the market because borrowers tend to borrow less. This allows the central bank to tighten its balance sheets, which can slow or reduce inflation.

HOW A HIGH PREMIUM RATE COULD AFFECT CANADIANS

As prime rates continue to rise, borrowing money becomes more expensive. People trying to get approved for a mortgage, small business loan, or car financing will need to take out higher interest rate loans. This, in turn, is causing many Canadians to rethink their decision to buy a new home, finance a new car, or start a business.

Higher prime rates could also significantly affect consumers with variable rate mortgages or those who need to be refinanced. This would result in much higher mortgage payments, which could lead to more foreclosures or downsizing of homes.

Higher prime rates also affect consumers, as credit card companies increase their adjustable interest rates. This means that people with a credit card balance could end up paying even more.

Depending on how the Canadian economy reacts to recent central bank rate hikes, we could see the prime rate continue to rise into early 2023.

Hopefully it will calm down by mid to late 2023, but the verdict is still out, and it all depends on how the Bank of Canada decides to move forward with its current policy. quantitative tightening.

Christopher Liew is a CFA charterholder and former financial advisor. He writes personal finance advice for thousands of Canadian readers daily on his Wealth Awesome website.

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