Policy interest rate

Each central bank has a main interest rate that it adjusts to carry out monetary policy. In the UK it is Bank Rate, set by the Bank of England; in the euro area the European Central Bank steers policy through its deposit facility rate; in the United States the Federal Reserve sets a target range for the federal funds rate, at which banks lend reserves to each other overnight. The central bank makes its chosen rate effective mainly through the interest it pays or charges on money that banks hold with it or borrow from it.

Changes in the policy rate ripple outwards. Commercial banks adjust rates on variable mortgages, loans and savings; short-term bond yields move with expectations of the policy rate; and currencies, share prices and property values respond too. Raising rates tends to cool spending and inflation; cutting them tends to support activity. The effects arrive with long and uncertain lags, often a year or more. Markets usually move on changes in expected future rates rather than on the decision itself, which is why a widely anticipated change can leave them almost unmoved.