The Bank of Canada lowered its key interest rates to 2.25 per cent on Wednesday, continuing a rate-cutting cycle that began in June 2024.
Ahead of this latest change, CBC News spoke with economists, mortgage experts and financial planners who explained how interest rates work and what they watch for with every Bank of Canada announcement.
Here’s what lower interest rates mean for you, small businesses and the Canadian economy.
What are interest rates, anyway?
Interest is what consumers or institutions pay to borrow money. It’s also what a bank might pay a client for leaving money in their account.
When you take out a loan, “you’ll be given the cash and you will need to repay a little bit of that loan over time,” said Andrew DiCapua, principal economist at the Canadian Chamber of Commerce in Ottawa.
“Some of what that repayment includes is interest.”
Commercial banks like RBC, Scotiabank, TD Bank, CIBC and BMO use “prime rates,” which are their starting rates to charge consumers who borrow money. That rate is usually combined with a percentage that is calculated based on a person’s creditworthiness.
Those prime rates are guided by the Bank of Canada’s overnight interest rate — a tool that central banks use to keep inflation in check.
When inflation is running too high, the Bank of Canada might raise that benchmark rate to discourage people from borrowing (and spending) money.
DiCapua said this could, for example, encourage someone shopping for a new car to “get a smaller car or a cheaper car” — or delay buying a car altogether.
But when rates come down, that makes borrowing money cheaper. And that often encourages people to spend more, which can lead to economic growth.
Lower interest rates can mean different things for different parts of the economy. Because of that, the central bank balances potential growth against the risk of inflation when setting its benchmark rate.
How interest rates impact the housing market
Homeowners — specifically those with a variable rate mortgage — are among those who feel immediate relief when the Bank of Canada lowers its interest rate.
Their monthly mortgage payments will fluctuate as rates do.
Prospective homeowners might also be incentivized to jump into the market when lenders offer a lower variable rate, said DiCapua.
The lower benchmark rate could also help those potential buyers lock in a lower “fixed” mortgage rate, which won’t fluctuate with future interest rate changes.
September and October are usually the weaker months for the markets, but this year’s rally keeps surprising. Not so surprising is Canada’s central bank decision last week to lower its key interest rate by 25 basis points. Mark Ting from Foundation Wealth joins CBC’s Dan Burritt to break down what it means for those shopping around for a mortgage.
That’s why a lower interest rate can lead to more home sales, which can in turn impact the economy. When rates trend lower, “we often see a psychological shift among buyers,” said Penelope Graham, a mortgage expert at RateHub.ca.
“Just having that edge taken off with lower interest rates often does spur more activity in the housing market, especially if people are of the ‘if I don’t move now, I’m going to miss out’ mindset,” she said.
How interest rates impact small businesses
Without the burden of high housing-related payments, consumers might devote more of their budget to buying goods and services, putting their money to work in other parts of the economy.
Those consumers “might have, for example, more disposable income to purchase more goods at retailers or purchase more experiences at hospitality businesses,” said Simon Gaudreault, chief economist and vice-president of research at the Canadian Federation of Independent Business.
Central banks typically raise interest rates to get prices under control during times of inflation, but the Bank of Canada and the U.S. Federal Reserve just cut rates. Andrew Chang explains how Trump’s tariffs and a slumping job market led to the same inflection point for the countries’ duelling economies.
Images provided by Getty Images, The Canadian Press and Reuters.
Plus, small businesses might be carrying their own variable rate mortgages or other loans (like a manufacturing company that borrowed money to buy expensive equipment).
If the rate goes down, “that’s good news for [those] business owners,” said Gaudreault.
But even as the central bank continues cutting rates, lower interest rates don’t automatically give businesses a cheery outlook.
The Bank of Canada recently asked businesses how they’re feeling about the economy, and the results were fairly subdued, particularly in the context of a trade war that has turned uncertainty into the new normal.
As Gaudreault notes, businesses are struggling with labour shortages and rising operating costs (like insurance premiums), and the cost of resources have gone up with inflation and tariffs.
“There is so much uncertainty at the moment, such weakness in the economy that businesses have to be very, very careful with where they put their money,” said Gaudreault.
“There isn’t much money for new investments or new hiring. They keep their money to face all of those higher operating costs.”
How interest rates impact personal finances
When it comes to personal loans — like the car loan example from earlier — the cost of borrowing will come down with prime rates, said Shannon Lee Simmons, a Toronto-based certified financial planner and founder of the New School of Finance.
The cost of borrowing money with a credit card or credit line might also come down through cheaper debt payments, noted Simmons.
If the cost of borrowing on a line of credit is high, then a new homeowner might hold off on a renovation, for example. If rates go down, then they might use credit to fund that renovation.
But lower interest rates might be less welcomed by Canadians who are trying to save and grow their money because financial institutions will pay consumers less to hold onto their cash.
Getting lower interest payouts from savings accounts and Guaranteed Investment Certificates (GICs) can feel “frustrating,” said Simmons.
“But if you are invested in the stock market and you hold fixed income products like bonds — typically speaking, when interest rates go down, bond prices will pop up. And so it really depends on your asset mix,” she said.
What else do I need to know about rate cuts?
“The relationship between interest rates and prices [depends] on how fast or slow the economy is growing relative to the economy’s ability to produce goods and services,” said DiCapua.
When demand outweighs supply — and the economy requires more workers, more capacity or more machinery than what’s available — that can lead to higher prices, he explained.
But it can take a while for any interest rate changes to flow through the economy. The traditional view among economists is that these changes take about a year and a half, according to DiCapua.
“That’s because, of course, the lending rate affects the banks, the banks then change their rates and then those rates — the prime rate that the banks use — then flow through the various financial instruments and loans through the system,” he said.
He said the Bank of Canada’s interest rate decisions are a clear signal for Canadians who want to know “where the economy is going.”
That signal can influence the public’s confidence in the economy, which “can impact consumer behaviour, can impact business decision-making,” said DiCapua.
“That is sort of a soft power, as I’ll put it, that the Bank of Canada does have.”
