Posted at 7:00 am
Why are we saying the Bank of Canada is raising its key rate by 75 basis points? This is confusing. Wouldn’t it be easier to say 0.75% or even 1% instead of 100 basis points?
According to our guest expert, the answer to this question has two parts.
First, we need to define what “base point” means. A basis point (or 1 bp in the financial jargon of economists) is exactly equal to 0.01% or 1 hundredth of a percent.
“In a nutshell, we use this term when we’re dealing with very small numbers…like the interest rate,” explains Sébastien McMahon, chief strategist, chief economist and portfolio manager at Industrial Alliance, Investment Management.
“You must have noticed that interest rate levels move very little,” this asset allocation specialist points out.
“For example, the 10-year Government of Canada yield has risen from around 1.5% at the start of the year to nearly 3.3% today. The same applies to the Bank of Canada, which traditionally moves its key rate at 0.25%. »
Sébastien McMahon clarified that when reporting the change in interest rates within a day, it is much easier to say, for example, that the change was “five basis points” rather than “zero zero five percent”. It is a matter of simplicity and efficiency of the language.
A second, equally important reason, he says, is to avoid confusion with a commensurate change in price.
He points out that when we talk about stock market returns, for example, we report a 1% increase when the S&P/TSX — the main index of the Toronto Stock Exchange — rises 200 points, going from 20,000 to 20,200.
“However, in the case of the interest rate, we are interested in the absolute variation of the rate, not the proportional change compared to the previous level,” says Sébastien Mc Mahon.
Using the jargon of “basis points” thus adds clarity and suggests that we are talking about a variation in the rate and not a price or value.
In addition, Sébastien Mc Mahon points out that economists like him generally use the term “percentage points” (1 percentage point equals 1%) to talk about variations in economic data, because their usual movements are generally measured on this scale and to distinguish interest rate movements , which are generally transmitted in “base points”.
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