London Daily

Focus on the big picture.
Saturday, Nov 22, 2025

Why are central banks pushing to raise interest rates?

Why are central banks pushing to raise interest rates?

Banks are raising rates to bring down inflation but there is a risk to economic growth

Central banks around the world are pushing for the sharpest rise in interest rates in decades in response to soaring inflation.

With living costs across advanced economies rising at the fastest annual rate since the 1980s, the US Federal Reserve, Bank of England and European Central Bank are taking aggressive action to cool inflationary pressure.

However, there are risks for households and businesses as economic growth falters. Here are the reasons rising rates matter:

Why are central banks raising interest rates?


The impact of the Covid pandemic, supply chain disruption, worker shortages and Russia’s war in Ukraine driving up energy prices has fuelled a dramatic surge in the rate of inflation over recent months.

Across the OECD group of wealthy nations, inflation has reached 9.2% – the highest since 1988. Britain has the highest rate in the G7 group of rich countries – the UK, US, Canada, France, Italy, Germany and Japan – with the consumer price index (CPI) measure of inflation hitting 9% in April, the highest since 1982.

Central banks have mandates from their national governments to target low and stable inflation, typically of around 2%, while also bearing in mind the strength of the economy and outlook for jobs.

The Bank of England is widely expected to raise its base rate by 0.25 percentage points to 1.25% on Thursday for the fifth consecutive time.

The US Federal Reserve raised interest rates by 0.75 percentage points on Wednesday, to a range between 1.5% and 1.75%. It was the largest hike since 1994 in response to US inflation which soared to a 40-year high of 8.6% last month.

The European Central Bank plans to raise interest rates in July and September, after announcing that it would halt its quantitative easing bond-buying programme next month.

How does it help to bring down inflation?


Inflation measures the annual increase in average consumer prices for a basket of goods and services. Prices typically rise when either supply is constrained, or demand outstrips supply.

Higher rates make borrowing more expensive and encourage saving. When debt is costlier, this in turn can influence consumer demand for goods and services, as well as business investment and hiring intensions. This can help to cool inflation when demand is outstripping supply.

In addition, rising interest rates typically lead to a stronger currency on the foreign exchange markets. This helps to reduce the price of imported goods, and may be a key consideration for the Bank of England. With aggressive rate rises from the Fed, the American currency has strengthened to the highest level in two decades, while the pound has hit the lowest level against the dollar since the spread of the Covid pandemic in March 2020.

“The Bank will be keeping an eye on what’s happening with sterling,” said James Smith, an economist at ING. “When higher energy costs are priced in dollars, at the margin, a weaker pound is making that worse.”

Central banks also believe in the power of sending signals. By aggressively raising rates, central banks hope to demonstrate their commitment to bringing inflation back to their target. This is aimed to prevent expectations for persistently higher inflation, which could otherwise tempt workers to demand bigger pay rises or encourage companies to keep putting up their prices.

How does it affect you?


When the central bank raises interest rates, high street lenders pass them on to consumer and commercial borrowers and savers. While they’re typically slower to raise the interest paid on deposits, mortgage costs can rise quite quickly.

Those on standard variable rates – which track the Bank’s base rate – are the first to see the difference. However, most homeowners have fixed-rate mortgages. This means you won’t see higher costs until you come to the end of your term. This is one of the reasons central banks say it can take time for higher rates to counter inflation.

Renters are also likely to come under pressure, as buy-to-let landlords pass on higher borrowing costs to their tenants.

When the Bank raised interest rates in May by 0.25 percentage points to 1%, analysts at Hargreaves Lansdown estimated it would push mortgage payments up by over £40 per month.

Against a backdrop of rising interest rates, the Office for Budget Responsibility estimates household debt servicing costs to rise from £55bn to £83bn over the next two years.

What are the dangers?


Suppressing consumer demand runs the risk of squashing economic growth. With soaring living costs already threatening a spending downturn, this could exacerbate the risk of recession.

Andrew Bailey, the Bank’s governor, has warned that Threadneedle Street must tread a “narrow path” between responding to high inflation and weaker growth. In the US, some analysts expect the Fed could be forced to begin cutting interest rates again from as early as next year to counter recessionary risks.

Britain’s economy is forecast to slow to a standstill next year, with the country forecast to fall to the bottom of the OECD’s growth league table with the exception of Russia.

Beyond concerns over economic growth and inflation, there are questions over financial stability to consider.

Are governments at risk?


In the Eurozone, higher interest rates and the end of bond buying from the ECB has fuelled concerns over the fragmentation of the single currency bloc, reminiscent of the sovereign debt crisis in the middle of the last decade.

The central bank sought to allay concerns with an unscheduled meeting on Wednesday, after a sharp rise in Italian and Greek borrowing costs, as investors bet the reduction of economic stimulus could place pressure on highly-indebted governments.

Katharine Neiss, chief European economist at PGIM Fixed Income, said: “It remains an open question if the euro area economy can withstand interest rates significantly above 0%.”

Developing countries with high amounts of dollar borrowing could also be hit hard, as the higher interest rates from the Fed and a stronger American currency drive up their repayments.

Sri Lanka, faced with a political and economic crisis, has already defaulted on its debts, while analysts said countries including Ghana and Pakistan could also face difficulties.

Newsletter

Related Articles

0:00
0:00
Close
Zelenskyy Signals Progress Toward Ending the War: ‘One of the Hardest Moments in History’ (end of his business model?)
U.S. Issues Alert Declaring Venezuelan Airspace a Hazard Due to Escalating Security Conditions
The U.S. State Department Announces That Mass Migration Constitutes an Existential Threat to Western Civilization and Undermines the Stability of Key American Allies
Students Challenge AI-Driven Teaching at University of Staffordshire
Pikeville Medical Center Partners with UK’s Golisano Children’s Network to Expand Pediatric Care
Germany, France and UK Confirm Full Support for Ukraine in US-Backed Security Plan
UK Low-Traffic Neighbourhoods Face Rising Backlash as Pandemic Schemes Unravel
UK Records Coldest Night of Autumn as Sub-Zero Conditions Sweep the Country
UK at Risk of Losing International Doctors as Workforce Exodus Grows, Regulator Warns
ASU Launches ASU London, Extending Its Innovation Brand to the UK Education Market
UK Prime Minister Keir Starmer to Visit China in January as Diplomatic Reset Accelerates
Google Launches Voluntary Buyouts for UK Staff Amid AI-Driven Company Realignment
UK braces for freezing snap as snow and ice warnings escalate
Majority of UK Novelists Fear AI Could Displace Their Work, Cambridge Study Finds
UK's Carrier Strike Group Achieves Full Operational Capability During NATO Drill in Mediterranean
Trump and Mamdani to Meet at the White House: “The Communist Asked”
Nvidia Again Beats Forecasts, Shares Jump in After-Hours Trading
Wintry Conditions Persist Along UK Coasts After Up to Seven Centimetres of Snow
UK Inflation Eases to 3.6 % in October, Opening Door for Rate Cut
UK Accelerates Munitions Factory Build-Out to Reinforce Warfighting Readiness
UK Consumer Optimism Plunges Ahead of November Budget
A Decade of Innovation Stagnation at Apple: The Cook Era Critique
Caribbean Reparations Commission Seeks ‘Mutually Beneficial’ Justice from UK
EU Insists UK Must Contribute Financially for Access to Electricity Market and Broader Ties
UK to Outlaw Live-Event Ticket Resales Above Face Value
President Donald Trump Hosts Saudi Crown Prince Mohammed bin Salman at White House to Seal Major Defence and Investment Deals
German Entertainment Icons Alice and Ellen Kessler Die Together at Age 89
UK Unveils Sweeping Asylum Reforms with 20-Year Settlement Wait and Conditional Status
UK Orders Twitter Hacker to Repay £4.1 Million Following 2020 High-Profile Breach
Popeyes UK Eyes Century Mark as Fried-Chicken Chain Accelerates Roll-out
Two-thirds of UK nurses report working while unwell amid staffing crisis
Britain to Reform Human-Rights Laws in Sweeping Asylum Policy Overhaul
Nearly Half of Job Losses Under Labour Government Affect UK Youth
UK Chancellor Reeves Eyes High-Value Home Levy in Budget to Raise Tens of Billions
UK Urges Poland to Choose Swedish Submarines in Multi-Billion € Defence Bid
US Border Czar Tom Homan Declares UK No Longer a ‘Friend’ Amid Intelligence Rift
UK Announces Reversal of Income Tax Hike Plans Ahead of Budget
Starmer Faces Mounting Turmoil as Leaked Briefings Ignite Leadership Plot Rumours
UK Commentator Sami Hamdi Returns Home After US Visa Revocation and Detention
UK Eyes Denmark-Style Asylum Rules in Major Migration Shift
UK Signals Intelligence Freeze Amid US Maritime Drug-Strike Campaign
TikTok Awards UK & Ireland 2025 Celebrates Top Creators Including Max Klymenko as Creator of the Year
UK Growth Nearly Stalls at 0.1% in Q3 as Cyberattack Halts Car Production
Apple Denied Permission to Appeal UK App Store Ruling, Faces Over £1bn Liability
UK Chooses Wylfa for First Small Modular Reactors, Drawing Sharp U.S. Objection
Starmer Faces Growing Labour Backlash as Briefing Sparks Authority Crisis
Reform UK Withdraws from BBC Documentary Amid Legal Storm Over Trump Speech Edit
UK Prime Minister Attempts to Reassert Authority Amid Internal Labour Leadership Drama
UK Upholds Firm Rules on Stablecoins to Shield Financial System
Brussels Divided as UK-EU Reset Stalls Over Budget Access
×