Trading term

What is Central bank?

A central bank is the institution that sets a country's policy rate and is charged with keeping inflation stable. The Federal Reserve, the ECB and the Bank of England all aim at 2% inflation; the Reserve Bank of Australia aims at a 2-3% band.

A central bank isn't a bank you can open an account with. It's the bank that ordinary banks use. Its main lever is a single number, the policy rate, and in most wealthy countries its main job is a published inflation target that the rate is moved to hit.

That target is why rates move at all. The Fed targets 2%, the ECB targets 2%, and the Bank of England is given a 2% target by the government. The Reserve Bank of Australia is the odd one out with a 2-3% band, and its own explainer says policy aims at the midpoint. When inflation runs above target, the committee raises the rate to make borrowing dearer and cool spending. When it runs below, the committee cuts. Your mortgage quote, your savings rate and a company's cost of debt all follow from that decision.

2% is a policy choice rather than a law of nature, and each bank publishes its own in its own strategy document. Central banks do plenty besides: issuing the currency, supervising banks, acting as the lender of last resort in a crisis. The rate is simply the part that reaches your money every month.

For example

Inflation is running at 5% and the Federal Reserve targets 2%. The committee raises the policy rate, which makes borrowing more expensive and slows spending. Every rate built on top of the base moves with it, from mortgages down to what your savings account pays.

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Why it matters to you

A committee that meets a few times a year is the reason your mortgage quote changed, and the reason your savings rate did or didn't follow it. You have no say in the decision. What you do have is the target, published in plain words, and the reasoning behind every move. That makes the direction of rates one of the few things in finance where you can read what the decision-maker is actually trying to achieve.

⚠ A rate cut is not a cut to your rate

The central bank sets the base and nothing else. Your bank decides what it pays you and charges you by adding its own margin on top. In 2025 the US base averaged 4.21% while an ordinary savings account paid 0.40%. Changes do pass through, but rarely one for one and rarely at the same speed in both directions.

Frequently asked questions

What does a central bank do?

It sets the country's policy rate to meet an inflation target, issues the currency, oversees the banking system, and lends to banks in a crisis. Setting the rate is the part that touches everyday money most directly.

Why do central banks target 2% inflation?

It's a deliberate compromise: high enough to keep a safe distance from falling prices, low enough that households and businesses can plan. Each bank publishes its own figure. The Fed, the ECB and the Bank of England settled on 2%; the RBA uses a 2-3% range and aims at the midpoint.

Is a central bank part of the government?

It varies, and most are built to be operationally independent. The UK is the clear example of the split: the government sets the Bank of England's 2% target, and the Bank decides what rate to use to reach it. The Fed's target is set by the FOMC itself.

How often do central banks change rates?

They meet on a published calendar, usually around eight times a year, and can leave the rate untouched for long stretches. The US annual average sat below 0.20% every year from 2009 to 2015, then went from 0.08% in 2021 to 5.02% in 2023.

Read the full guide

How markets workWhat Is an Interest Rate? Who Sets It, and Why It Moves Your MoneyAn interest rate is the price of borrowing money for a year. Who sets it, why it moves, and why everything you own gets repriced when it does.12 min read

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