How central banks work, and what the key rate does

What a key rate is

A central bank is the bank of banks. Commercial banks keep their spare cash with it as reserves and borrow from it when they run short. The interest it pays on those reserves and charges on those loans sets the price of overnight money for the whole banking system: no bank lends to another for much less than the central bank would pay it, or borrows for much more than the central bank would charge. That price is the key rate, also called the policy rate.

Each central bank names it its own way: the federal funds rate in the US, the deposit facility rate in the euro area, Bank Rate in the UK, the key rate in Russia, the Selic in Brazil, the cash rate in Australia. The Fed sets a range a quarter of a point wide, 3.75–4.00% on November 3, 2026; the rate banks actually traded at was 3.88% on November 9, 2026. A year earlier the range's midpoint was the same, 3.875%.

Almost every other interest rate is priced off the key rate, directly or through bets on where it goes next: what banks pay on deposits, what they charge on loans, what investors ask for short-term government debt. Raise it and borrowing gets dearer and saving more rewarding; over months that cools spending, hiring and price rises. Cut it and the opposite happens. A central bank cannot print a job or freeze a price; it can only change what money costs, and wait.

From the key rate to your loan: the chain

Here is the chain as it ran in the Fed's last hiking cycle, 2022–23. The federal funds rate climbed from 0.20% in March 2022 to 5.33% in August 2023: +5.13 pp. Each card follows one link from the start of the cycle to its turning point and shows where it stands now; the small line is its monthly data since 2019.

The money market moved almost one for one: the 3-month Treasury bill rose 4.90 pp, 96% of the Fed's rise. The prime rate, which big US banks peg to the Fed's rate, rose 5.13 pp. Mortgage rates, which follow long-term bond yields more than the overnight rate, rose 3.40 pp: 66% of the Fed's rise. Car loans rose 3.78 pp (74%) and credit-card rates 7.03 pp (137%).

Housing starts, a kind of spending that leans heavily on loans, fell from 1.7M a year to 1.27M in Jul 2024, 28 months after the cycle began (−25%). Unemployment kept falling for 13 months, to 3.4% in Apr 2023, before it turned up; in Oct 2026 it was 4.1%. Inflation, already 8.6% when the cycle began, peaked at 9.0% in Jun 2022, 3 months in, and was 3.7% in Sep 2026.

How long it takes: every hiking cycle since 1954

One cycle is an anecdote. Below are all 15 hiking cycles of the federal funds rate since November 1954, lined up on the month each began. Short-term rates follow at once: the 3-month bill rose a median 89% as much as the Fed's rate, the prime rate 90%. Mortgage rates moved less, a median 40% (9 cycles since their data begin in 1973). Then come the slow links: housing starts reached their low a median 27 months after a cycle began, unemployment its low 25 months in, and inflation its peak 28 months in.

Economists call this “long and variable lags”, and the spread is the variable part: the unemployment low came anywhere from 5 to 48 months after the start, the inflation peak from 0 to 36. These are what followed the hikes, not proof that the hikes caused them. Oil shocks, wars, a pandemic, and whatever made the Fed hike in the first place, all sit in the same years.

Key rates around the world

The Bank for International Settlements, the central banks' own bank, collects the key rates of 38 central banks. On the latest day of its data the highest was Türkiye's at 36%, then Russia (14%) and Brazil (13.75%). The lowest, 0%, is in Switzerland. The median central bank charges 4.25%.

Over the past year 14 central banks raised the rate, 13 cut it and 11 left it where it was. Why are rates so far apart? Mostly inflation: to slow price rises a central bank has to hold its rate above the inflation it is fighting, and inflation differs a lot from one country to the next (see the targets below).

2021–2023: the hiking wave

When inflation jumped after the pandemic, central banks raised rates almost in unison: 36 of the 38 raised at least once between January 2021 and December 2023. In September 2022 alone, 27 of them raised their rate in the same month. The median one lifted it by 5.03 pp from its last rate before the first hike to its peak in those years.

First to move, in March 2021, were Türkiye, Russia, Brazil and Denmark. The Bank of England began in Dec 2021, the Fed in Mar 2022, the ECB in Jul 2022 and the Bank of Japan only in Mar 2024. Japan and China did not raise theirs at all in 2021–2023.

Then the wave turned: since January 2024, 37 of the 38 have cut their rate at least once.

Below zero: the negative-rate club

A negative key rate means banks pay the central bank to keep money with it overnight: a nudge to lend the money out instead. 5 economies in the data went below zero: Denmark, the euro area, Switzerland, Sweden and Japan. Denmark was first, in July 2012; Japan was the last to leave, its last month below zero being February 2024.

The deepest rate was −0.75% (Denmark and Switzerland). Denmark spent the most time below zero: 117 months in all, about 9.8 years. From Sep 2016 to Dec 2019, 5 of them were below zero at the same time.

What central banks aim for

Most central banks are told by law, or by their government, to keep prices stable, and most spell that out as a number. The Federal Reserve, European Central Bank, Bank of England, Bank of Japan and Sveriges Riksbank each aim for 2%; the Bank of Russia for 4%; the Central Bank of the Republic of Türkiye for 5% in the medium term. The Fed is told to pursue maximum employment and stable prices at once, which is why its job is called a “dual mandate”.

How close did they come? In 2025, 4 of the 10 kept inflation inside their own range or within half a point of their target; 6 ran above it, the furthest first: Central Bank of the Republic of Türkiye, Bank of Russia, Bank of England, Bank of Japan, Federal Reserve and Sveriges Riksbank.