The government does not set the prime rate. Prime rate is a tool for a bank to simplify adjusting the interest on their products, from mortgages to credit lines. Each bank set its own prime rate, and, technically, it can be set to any number, as long as it moves in lockstep with BofC overnight rate. In practice, however, all banks set their prime rates to BofC rate 2%. Do not ask me where these 2% came from, but they allow banks to offer loans at less then prime and still earn money on the difference with BofC overnight rate.

The Bank of Canada overnight lending rate at the moment is 1%. Current prime rate is 3%. There is a 2% difference between the BOC overnight lending rate vs. prime rate used by banks, The overnight lending rate is used by the banks to borrow money from each other overnight. Any changes to the overnight lending rate would change the prime rate used by banks to lend money. There are 8 time in a year that the BOC would review the rate and change it if needed. This rate also affect the Canadian dollar`s exchange rate.

The BOC overnight lending rate dictates the prime rate. Currently (August 2011) overnight lending is 1% and prime is set at 3%. You still get discounted rates for mortgages like Prime minus 0,75% or 2.25%. Every time overnight lending rate changes, prime rate and discounted variable rates changes. This also applies to your personal line of credit where you would get prime plus 3% or 6% and the like.