Why are the operating bands effective at keeping the overnight rate - ProProfs Discuss

# Why are the operating bands effective at keeping the overnight rate within the bands?

Asked by London, Last updated: May 15, 2024

#### John Smith

John Smith

Answered Sep 08, 2016

Assume the upper band is 5.50% and the lower band is 5.00%. The target for the overnight rate of interest is 5.25%. To see why the bank rate is effective at keeping interest rates below the upper band, imagine the following two scenarios:

1. Interest rates as a result of market forces start climbing higher from 5.25% toward the upper band of 5.50%. Since the bank of Canada stands ready to lend at 5.50%, there isn't much reason for the market interest rate to rise above the band (why borrow from someone else at a rate above 5.50% when you can borrow from the bank of Canada at the 5.50% bank rate).

2. What if, for some reason, the market interest rate was trading higher than the upper band as a result of market forces? The rate would quickly come back to the upper band because the bank of Canada offers a better lending rate than the current market rate. This has the effect of bringing the market interest rate down. This is a poor example when you consider that the rate shouldn't stray above the upper band. But in this fictitious example, you can see why the rate certainly wouldnt remain above the upper band for any length of time if, for some reason, the market rate found itself higher than the upper band.