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Interest Rates, Inflation & The Bank of Canada

Written by Posted On Tuesday, 20 April 2004 00:00

Most Canadians would acknowledge the importance of interest rates to their current and future financial security, but almost as many would also admit they do not know as much about Canada's monetary system as they should. Those who buy, own and sell real estate benefit from learning as much about the way money works as possible. The Bank of Canada, our Central Bank, is a good place to start.

Although the media have trained us to link the Bank of Canada with an increase or decrease in mortgage rates, our Central Bank does not set the prime rate, commercial banks do. The Bank of Canada does influence interest rates, especially short-term interest rates, when it sets the Target for the Overnight Rate . This is the average rate that the Bank wants to see in the marketplace, where the major financial institutions and large corporations lend each other money on a very short-term -- or "overnight" -- basis. Fluctuations in this rate influence other interest rates and the rates that financial institutions charge on loans and mortgages.

Changes in the Bank of Canada's Overnight Rate Target usually lead to changes in the "prime rate." The prime rate is the reference point for interest rates charged on many personal loans, mortgages and business loans, as well as interest paid on deposits and investment certificates. Since the Bank has pre-set dates for changing its Overnight Rate Target, you might plan your financial activities around these announcements since mortgage rates may rise or drop shortly after these announcements.

Over the years, the Bank of Canada has refined the way it conducts monetary policy. Previously, the Bank Rate was the official interest rate that Canadians could follow. Now, the Overnight Rate Target is considered more relevant for monetary policy and it is also the best rate to use when comparing our interest rates with those of other countries. The Overnight Rate Target corresponds to the U.S. Federal Reserve's "target for the federal funds rate," the Bank of England's two-week "repo rate" and the minimum bid rate for refinancing operations (the repo rate) at the European Central Bank.

The Bank of Canada was founded in 1934 as a privately owned corporation. Four years later, the Bank became a federal Crown corporation where the federal Minister of Finance holds the entire share capital issued by the Bank. The Bank "promotes the economic and financial well-being of Canada" by establishing monetary policy, supplying quality bank notes and overseeing Canada's financial system.

To influence the amount of currency in circulation and the interest rates, the Bank sets monetary policy, measures taken by the Bank to influence the economy by regulating the amount of money in circulation and by keeping inflation "low, stable and predictable." The Bank's Monetary Policy Report is a detailed summary of the Bank's policies and strategies, plus a look at the current economic climate and its implications for inflation, which may be useful in establishing your own real estate investment strategies. This Report is published semi-annually in April and October; regular updates are published in July and January.

According to the April 2004 Monetary Policy Report , the Bank expects the economy to grow by about 2 3/4 per cent in 2004, picking up to about 3 3/4 per cent in 2005. Core inflation -- which removes the most volatile components of the consumer price index and the impact of indirect taxes on the remaining components -- should average 1 1/2 per cent over the remainder of this year. As excess supply in the economy diminishes, core inflation is expected to move back to 2 per cent by the end of 2005.

Would you like to see the effects of inflation from 1914 to the present? Try out the Bank's Inflation Calculator . Or perhaps you want to know the effect of inflation on your investments and savings .

The Bank of Canada may make an off-beat contribution to your financial future, and therefore your real estate buying power, through the unclaimed balances it holds. As of December 31, 2003, approximately 789,415 unclaimed balances, worth some $227 million, were on the Bank's books. Is some of that yours ?

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PJ Wade

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