Policy Rate

Each central bank has its own main policy rate, with names such as the bank rate, the federal funds target rate, the main refinancing rate or the cash rate. It typically sets the rate at which banks can borrow from or deposit with the central bank, or the rate at which banks lend to each other overnight.

Changes to the policy rate ripple through the economy. When the central bank raises its policy rate, banks generally raise the rates they charge on loans and pay on savings. Borrowing becomes more expensive, encouraging people and businesses to spend less and save more, which helps reduce inflation. When the central bank cuts the rate, borrowing becomes cheaper, supporting spending and economic growth.

For example, if inflation is well above target, a central bank might raise its policy rate from 3% to 4% over several meetings to cool demand.

Policy rate decisions are usually made at scheduled meetings and are closely watched by financial markets. Changes affect mortgage rates, bond yields, exchange rates and share prices, and their full effect on the economy can take a year or more.