Any nation's central bank is in charge of preserving the stability of its financial system. The central bank is also in charge of carrying out the government's budgetary plans. The Bank can carry out its duties with the use of a few tools. One of the instruments in a central bank's toolbox is the ability to control the discount rate.
How does Discount Rate work?
The central bank is regarded as the lender of last resort. Financial institutions generally borrow from the central bank to stabilize their liquidity status in any nation. The interest rate that the central bank assesses to the lending financial institutions is known as the discount rate. These are short-term loans that are typically given out overnight. The cost of borrowing for the financial institutions is the interest rate levied by the central bank.
What occurs when the discount rate shifts?
The Central Bank uses the discount rate to promote or discourage borrowing by financial institutions, which has an effect on the availability of credit in the nation. The interest rate that financial institutions charge their customers changes when the cost of borrowing for the bank does. The purpose of altering the discount rate is to have an effect on the nation's money supply and, in turn, consumer spending.
Any change in the discount rate affects the interest rates charged on credit cards, overdrafts, loans, mortgages, and any other form of credit extended to customers because the interest charged by financial institutions depends on the cost of borrowing. This decreases or increases consumer spending in the economy.
Canadian viewpoint
In the previous week, the Bank of Canada increased the country's discount rate from 1.25 to 1.5 percent. In the previous 12 months, there had been four increases. By the second half of 2019, inflation is predicted to reach 2.5% before declining to approximately 2%.
The top five banks likewise raised their prime rates by up to 2.95% in response to the Bank of Canada's rate hike. Any bank's prime interest rate serves as the foundation for determining the interest rate for any product it offers to its clients. The risk considerations, credit history, collateral guarantees, and other factors also play a role in determining an item's interest rate. However, any change in the prime rate will inevitably impact the final rate.
What the future holds for Canadians
1. The cost of borrowing will rise, discouraging people from taking out new loans and increasing their spending. Spending will often decline, which will eventually aid in reducing the pressures of inflation on the economy. If the anticipated investment is not anticipated to produce significant returns, businesses may potentially postpone expansions and other borrowing plans.
2. Rising mortgage interest: Homebuyers can choose between fixed- and variable-rate mortgages. Any new mortgages will invariably cost more when bank prime rates rise, but existing borrowers with variable rates will also be impacted. In conjunction with the rate hike, their mortgage payments also rise. Existing fixed interest mortgages are unaffected by the rise in discount rates, but when these mortgages are extended, any anticipated increases and risks are taken into consideration as well.
3. A decline in home sales: Rising mortgage rates make it more difficult for people to purchase new homes, which slows down the real estate industry. The majority of consumers view buying a home as a long-term investment, and each rise in the mortgage not only makes it more expensive but also lowers their return on investment.
4. Greater incentive to save: An increase in prime rates also affects the savings rates that banks provide, giving customers a greater incentive to hold onto their money rather than spend it.
5. Lower consumer spending: Higher interest rates have a negative impact on consumer spending and investments, which results in a decline in total depositions. Lower demand slows down the economy's growth and relieves inflationary pressures.
6. Currency value increases: Investors are more likely to save when interest rates are higher, which may lead to an increase in investment into the nation and a consequent rise in currency value. Imports will rise as exports lose competitiveness.
7. Reduced confidence: An increase in interest rates has a negative impact on consumer and business confidence. They become less prone to making risky bets and purchases as a result.""" - https://www.affordablecebu.com/
