Rate Hike and Rate Cut
A rate hike is a central bank raising its key interest rate, usually to fight inflation; a rate cut lowers it, usually to support a slowing economy.
Few headlines move markets like a central bank raising or cutting rates. One decision changes what households pay on loans, what savers earn and how investors value almost every asset. Knowing why banks hike or cut — and how the effect travels — helps you read the news before the market does.
- Category
- Fundamentals and Macroeconomics
- Reading time
- 4 min
- Also called
- Interest rate rise, Interest rate cut, Rate increase
- Updated
Hikes and cuts in plain words
To bring inflation down, a central bank raises interest rates; borrowing costs more and saving pays more, so spending falls.1
To support the economy, it lowers rates.1
In the US the main tool is the federal funds rate, the rate banks pay for overnight borrowing.2 See Central Bank and Inflation.
How a rate decision works, step by step
The committee meets
The Bank of England's committee meets eight times a year to set Bank Rate.3 In the US it is the Federal Open Market Committee.
It sets the policy rate
Bank Rate, for example, is the rate paid on overnight deposits held at the central bank by banks.1
Other rates follow
Changes in the policy rate influence other interest rates and borrowing costs for households and businesses.2
Spending responds
Lower rates make borrowing cheaper, so households tend to spend more.2
Inflation responds
Higher rates mean less spending, which brings inflation down.1
Effects take time
The links from policy to inflation and jobs are not direct or immediate.2
Worked examples
Example 1 — A 0.25-point hike on a loan
+$500 a yearYou have a $200,000 variable-rate loan. The policy rate rises 0.25 points (25 basis points) and your loan rate follows.
| Extra annual interest | $200,000 × 0.25% = $500 |
Higher interest rates mean borrowing costs more.1
Example 2 — A cut and your savings
−$50 a yearYou hold $10,000 in savings at 4%. After a 0.50-point cut, the rate drops to 3.5%.
| Interest before | $400 a year |
| Interest after | $350 a year |
| Difference | −$50 a year |
Lower rates are used to support the economy by boosting spending.1 For savers, the flip side is a lower return.
Example 3 — Simple interest
Repay $101You borrow $100 at a 1% lending rate for a year.
| Interest | $100 × 1% = $1 |
| Repay | $101 |
The Bank of England's own example: borrow £100 at 1% and you repay £101 a year later; a hike raises that cost.3
Rate hike vs rate cut
| Aspect | Rate hike | Rate cut |
|---|---|---|
| Usual reason | Inflation too high | Weak economy or low inflation |
| Borrowing costs | Rise | Fall |
| Savings returns | Rise | Fall |
| Typical market reaction | Bond prices fall, currency often firms | Bond prices rise, currency often softens |
Why traders watch rate decisions
Bonds
Rate changes move Treasury Bills, Notes and Bonds prices and yields.
Stocks
Higher rates raise discount rates and borrowing costs for companies.
Currencies
Rate differences between countries move exchange rates.
Positioning
Traders price expected moves in advance using SOFR futures and similar markets.
Advantages and disadvantages
Advantages
- Hikes can bring inflation back to target.
- Cuts can soften a downturn.
- Decisions are scheduled and widely explained.
- One tool reaches the whole economy.
Disadvantages
- Effects arrive with long and variable lags.
- Hikes can tip an economy into Recession.
- Cuts can fuel asset bubbles or inflation.
- Expectations are often priced in before the decision.
Going deeper
Read as far as you need. Each level builds on the one before it.
Why rates move
Beginner
Transmission
Intermediate
When cuts run out
Advanced
In a downturn, the Fed may cut its policy rate close to zero and then reach for other tools.2 The Bank of England turns to QE when Bank Rate can barely fall further.1 See Real Yield.
Common mistakes
Trading only the decision
Ignoring that markets price expectations in advance.
Forgetting the guidance
The statement about future moves can matter more than the move.
Expecting instant effects
Inflation and jobs respond slowly.
Assuming hikes always hurt stocks
Strong growth can offset higher rates.
Check your understanding
Test yourself before moving on. Each answer comes with an explanation.
Key points to remember
- A hike raises the policy rate; a cut lowers it.
- Hikes usually fight inflation; cuts support growth.
- Policy rates feed through to loans, savings and markets.
- Effects take time to reach inflation and jobs.
- Markets often price decisions before they happen.
Frequently asked questions
What is a basis point?
Do mortgage rates follow every hike?
Why do stocks sometimes rise after a hike?
Further learning
- Central Bank
Who sets policy rates.
- Federal Open Market Committee
The Fed's rate-setting committee.
- Inflation
The main reason for hikes.
- Interest Rate
How rates work across the economy.
Sources
This article is written in our own words. The sources below support the specific facts, rules and figures marked with a number in the text. Links open the original publisher’s page.
- Bank of England. Quantitative easing (opens in a new tab) Checked .
- Federal Reserve Board. How does the Federal Reserve affect inflation and employment? (opens in a new tab) Checked .
- Bank of England. Interest rates and Bank Rate (opens in a new tab) Checked .
Educational content, not financial advice. Examples use hypothetical prices and simplified costs; actual fees, margin rules and regulations vary by broker, market and country. We are not affiliated with any publisher linked above. Last reviewed . Report an error or request a source credit.