Why does the Bank of Canada have a 2-per-cent inflation target?

The Bank of Canada has raised its key interest rate again in an effort to bring down inflation, which remains above its target of two per cent year-over-year. But why does the bank believe a two per cent target is best?

The Bank of Canada has raised its key interest rate again in an effort to bring down inflation, which remains above its target of two per cent year-over-year.

The bank on Wednesday announced that it would raise the overnight rate by 25 basis points to five per cent, the highest it's been since 2001. One basis point is equal to one-hundredth of a percentage point.

This is the bank's 10th rate increase since March 2022, with inflation dropping from a peak of 8.1 per cent last summer to 3.4 per cent in May.

Now, the bank predicts that inflation will remain around three per cent over the coming year and won't reach two per cent until mid-2025, two fiscal quarters later than projected.

The Bank of Canada and the federal government agreed to target an inflation rate of two per cent in 1991 following a period of high annual inflation that surpassed 12 per cent in 1981.

The two per cent target serves as a midpoint between a range of one and three per cent.

The bank explained in 2020 that this "resulted in good overall economic performance" and an agreement on this target has been continually renewed since, including as recent as 2021 through to 2026.