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Central banks set a short-term policy rate that anchors what commercial banks pay to borrow reserves. Changes to that rate pass through to mortgage rates, corporate borrowing costs and the yields investors demand on government bonds.
How it works
Higher rates generally cool demand by making credit more expensive and saving more attractive; lower rates do the opposite. The effect arrives with long and variable lags, which is why policymakers rely on forecasts rather than current data alone.
Policy rates ripple through borrowing costs, asset prices and exchange rates. This explainer sets out how the transmission mechanism works — and where it can break down.
What to watch
The transmission is not mechanical. Expectations matter as much as the rate itself: forward guidance, balance-sheet policy and the credibility of the institution all shape how markets respond.
Key concepts
- Monetary policy
- Central banks
- Inflation
