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How the Bank of Canada’s interest rate works—and why it’s rising

The Bank of Canada has raised its policy interest rate by half a percentage point for the first time in decades, a move intended to slow runaway inflation. The rate hike brings the Bank’s policy interest rate, also known as the overnight rate, up to 1% from the previous 0.5%.

It’s the second time the Bank has raised its target interest rate this year, and the first time it has done so beyond a 0.25% increment since May 2000. After maintaining a benchmark rate of 0.25% in January—a record low first implemented in March 2020 in response to the COVID-19 pandemic—it increased the rate to half a percentage point in early March.

Inflation, as measured by the consumer price index (CPI), has fuelled the need for a tightening of monetary policy in Canada. In February 2022, inflation reached 5.7%, marking the largest gain in consumer prices since August 1991, according to Statistics Canada. As part of its mandate, the Bank of Canada aims to maintain inflation at a rate of 2% per year.

“Inflation is being driven by rising energy and food prices and supply disruptions, in combination with strong global and domestic demand,” the Bank said in a statement accompanying its April rate-hike decision. “CPI inflation is now expected to average almost 6% in the first half of 2022 and remain well above the control range throughout this year.”

The Bank expects inflation to remain above its target until 2024, noting that there’s “an increasing risk that expectations of elevated inflation could become entrenched.”

Hikes in the Bank’s target overnight rate are intended to help keep inflation in check. The increases also have far-reaching implications for your finances, whether you’re applying for a mortgage, repaying a student loan or living off retirement income. We take a look at how the Bank’s policy rate works, how it is set and what it means for you.

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