policy interest rate
When the news says 'the central bank raised rates today,' there is one specific number they are talking about: the policy interest rate. It is the single short-term interest rate that the central bank chooses to set, the lever it actually pulls. Think of it as the wholesale price of money for banks — the rate around which banks lend to and borrow from each other overnight. Move it, and almost every other interest rate in the economy tends to follow.
Different countries name it differently — the federal funds rate target in the U.S., the bank rate in the U.K., the deposit facility rate in the euro area — but the idea is the same. The central bank announces a target for this rate and then uses its tools (mainly open market operations and the interest it pays on reserves) to keep the actual rate close to the target. For example, if the bank sets the rate at 5 percent, banks will not lend to each other much below 5 percent (they could earn that safely elsewhere) nor much above (they could borrow cheaper), so the market rate settles near the target.
The policy rate matters because it is the starting point of the whole interest-rate chain. From it flow the rates on mortgages, credit cards, savings accounts, business loans and government bonds. By choosing one number, the central bank influences the cost of borrowing for an entire nation. The key subtlety: the bank directly controls only this very short-term rate. Long-term rates — like a 30-year mortgage — depend more on what markets expect the policy rate to be for years to come, which the bank can shape but not command.
When the Federal Reserve lifts its federal funds rate target by 0.25 percentage points, banks promptly raise the prime rate, and within days millions of credit-card and adjustable-mortgage payments rise too — one decision rippling out to ordinary household budgets.
One short-term rate set by the bank pulls a whole chain of borrowing costs.
The central bank sets a target, not the rate itself by fiat; it must actively use its tools to keep the market rate near that target. And it controls only the short-term rate, not long-term rates directly.