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Overnight rate is the interest rate at which major financial institutions lend or borrow funds from one another for a one-night period. It is a key benchmark rate used by central banks to influence monetary policy, liquidity, and economic activity.
What is the Overnight Rate?
The overnight rate reflects the cost of very short-term borrowing between banks. Central banks target this rate to control inflation, stabilize financial markets, and guide overall economic performance.
Definition
The overnight rate is the interest rate charged on short-term (one-day) loans between financial institutions, typically set or influenced by a nation’s central bank.
Key Takeaways
- A central tool for monetary policy.
- Influences interest rates across the economy, including mortgages and business loans.
- Reflects liquidity conditions in the banking system.
- Often known as the policy rate, repo rate, or interbank rate depending on the country.
Understanding the Overnight Rate
Banks often need to balance their daily reserves. Those with excess funds lend to those with shortfalls. The interest rate on these transactions is the overnight rate.
Central banks influence this rate by:
- Setting a target overnight rate
- Conducting open market operations
- Adjusting reserve requirements
- Providing standing lending and deposit facilities
A lower overnight rate encourages borrowing and economic expansion; a higher rate slows demand to control inflation.
Real-World Example
If the Federal Reserve lowers the federal funds rate (the U.S. overnight rate), banks can borrow more cheaply. This typically reduces interest rates for consumers and businesses, stimulating economic activity.
Importance in Business or Economics
The overnight rate matters because it:
- Affects interest rates across the entire economy.
- Influences inflation, spending, and investment.
- Signals central bank policy direction.
- Impacts currency value and financial market stability.
It is one of the most closely watched economic indicators globally.
Types or Variations
Federal Funds Rate (U.S.): Overnight rate between U.S. banks.
Repo Rate: Rate on repurchase agreements, used in many countries.
Interbank Overnight Rate: Market-driven lending rate between banks.
Policy Rate: Central bank’s official overnight target.
Related Terms
- Monetary Policy
- Open Market Operations
- Interest Rates
- Repo Rate
- Central Bank
Sources and Further Reading
- Federal Reserve – Interest Rates
- Bank of England – Monetary Policy
- European Central Bank – Key Rates
- Investopedia – Overnight Rate
Frequently Asked Questions (FAQs)
Does the overnight rate affect mortgage rates?
Yes. Changes to the overnight rate influence banks’ lending costs, which affect consumer loan rates.
Is the overnight rate the same worldwide?
No. Each central bank sets or targets its own overnight rate.
Why is the overnight rate important?
It is a primary tool used to control inflation and guide economic activity.
