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Key rate increases

Key rate increases

Generally speaking, one of central banks’ main purposes is to keep inflation under control but also to support economic activity. To achieve this, they put in place a monetary policy that takes account of economic developments. The main tool a central bank has to steer monetary policy is its key interest rate – the rate for loans to commercial banks, which then charge it, along with their own margins, for the loans that they in turn make to their clients, i.e. households and businesses.

When a central bank increases its key rate, commercial banks’ interest rates rise. The cost of borrowing becomes more expensive for households and businesses, which causes them to borrow less, and spend and invest less too.

Consequently, economic activity slows and this tends to contain inflation. If a central bank reduces its key rate, the inverse is true.

After more than a decade of highly accommodative monetary policies comprising low and indeed negative interest rates as well as longer-term refinancing operations and asset purchases, the post-Covid recovery, marked by a rapid increase in inflation all around the world, has led to the majority of central banks increasing their key rates.

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