The Bank of Canada cut key interest rates to 2.25% on Wednesday, continuing a cycle of rate cuts that began in June 2024.
Ahead of these latest changes, CBC News spoke with economists, mortgage experts and financial planners who explained how interest rates work and what they look for with every Bank of Canada announcement.
Here's what lower interest rates mean for you, your small business and the Canadian economy.
And what are the interest rates anyway?
Interest is what consumers or institutions pay to borrow money. This is also what the bank can pay the customer for leaving money in their account.
When you take out a loan, “you'll get cash and you'll have to repay a small portion of that loan over time,” said Andrew DiCapua, chief economist at the Canadian Chamber of Commerce in Ottawa.
“Part of what that repayment includes is interest.”
Commercial banks such as RBC, Scotiabank, TD Bank, CIBC and BMO use “prime rates,” which are their starting rates for charging consumers who borrow money. This rate is usually combined with interest, which is calculated based on the person's creditworthiness.
These key rates are determined by the Bank of Canada's overnight interest rate, a tool central banks use to curb inflation.
When inflation gets too high, the Bank of Canada can raise this benchmark rate to discourage people from borrowing (and spending) money.
DiCapua said this could, for example, encourage someone buying a new car to “buy a smaller car or a cheaper car” — or put off buying a car altogether.
But when rates go down, it makes it cheaper to borrow money. And this 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. For this reason, the central bank balances potential growth with the risk of inflation when setting the base rate.
How Interest Rates Affect the Housing Market
Homeowners, especially those with adjustable-rate mortgages, are among those who feel immediate relief when the Bank of Canada cuts interest rates.
Their monthly mortgage payments will fluctuate, as will the rates.
Prospective homeowners may also be incentivized to enter the market when lenders offer a lower variable rate, DiCapua said.
A lower prime rate may also help these potential buyers lock in a lower “fixed” mortgage rate that won't fluctuate with future interest rate changes.
September and October are typically the weakest months for markets, but this year's rally continues to surprise. The Canadian central bank's decision last week to cut its key interest rate by 25 basis points is not all that surprising. Foundation Wealth's Mark Ting joins CBC's Dan Burritt to talk about what this means for mortgage seekers.
This is why a lower interest rate can lead to more home sales, which in turn can impact the economy. When rates drop, “we often see a psychological shift among buyers,” said Penelope Graham, a mortgage expert at RateHub.ca.
“Removing that advantage through lower interest rates often stimulates more activity in the housing market, especially if people have the mindset of, 'If I don't move now, I'm missing out,'” she said.
How interest rates affect small businesses
Without the burden of high housing payments, consumers could spend more of their budgets on goods and services, putting their money to work in other parts of the economy.
These consumers “may, for example, have more disposable income to buy more goods at retail stores or purchase more experiences in the hospitality industry,” said Simon Gaudreau, chief economist and vice-president of research at the Canadian Federation of Independent Business.
Central banks typically raise interest rates to control prices during inflation, but the Bank of Canada and the US Federal Reserve simply cut rates. Andrew Chang explains how Trump's tariffs and a collapsing labor market have led to the same inflection point for these countries' competing economies. Images courtesy of Getty Images, The Canadian Press and Reuters.
In addition, small businesses may have their own adjustable rate mortgages or other loans (for example, a manufacturing company that borrowed money to purchase expensive equipment).
If the rate goes down, “that's good news for [those] business owners,” Gaudreau said.
But even as the central bank continues to cut rates, lower interest rates do not automatically create a favorable outlook for businesses.
The Bank of Canada recently surveyed businesses on how they felt about the economy and the results. were pretty depressedespecially in the context of a trade war that has made uncertainty the new normal.
As Gaudreau notes, businesses are struggling with labor shortages and rising operating costs (such as insurance premiums), and resource costs have risen along with inflation and tariffs.
“There's so much uncertainty right now, so much weakness in the economy, that businesses have to be very, very careful about where they put their money,” Gaudreau said.
“There's not a lot of money to make new investments or hire new employees. They're saving their money to cover all these higher operating costs.”
How interest rates affect personal finances
When it comes to personal loans—like the car loan example above—borrowing costs will drop along with prime rates, says Shannon Lee Simmons, a Toronto-based certified financial planner and founder of The New School of Finance.
The cost of borrowing money through a credit card or line of credit could also be lowered by cheaper debt payments, Simmons noted.
If the cost of borrowing on a line of credit is high, the new homeowner may delay renovations, for example. If rates drop, they can use the loan to finance renovations.
But lower interest rates may be less welcome to Canadians trying to save and grow their money because financial institutions will pay consumers less to hold on to their money.
Receiving lower interest payments on savings accounts and guaranteed investment certificates (GICs) can be frustrating,” Simmons said.
“But if you invest in the stock market and hold fixed income products like bonds—typically speaking, when interest rates fall, bond prices rise. And it really depends on your asset structure,” 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 an economy is growing relative to its ability to produce goods and services,” DiCapua said.
When demand exceeds supply (and the economy needs more workers, more capacity or more machinery than is available), it can lead to higher prices, he explained.
But any changes in interest rates may take some time to work their way through the economy. According to DiCapua, the traditional view among economists is that these changes will take about a year and a half.
“That's because, of course, the lending rate affects the banks, the banks then change their rates, and then those rates – the base rate that the banks use – then pass 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 to Canadians who want to know “where the economy is headed.”
That signal could affect public confidence in the economy, which “could affect consumer behavior, could affect business decisions,” DiCapua said.
“I would say that's kind of the soft power that the Bank of Canada has.”
