Central banks: who sets interest rates and why

The Novak family has a €150,000 mortgage with a variable rate. The evening news says: “The ECB has raised interest rates.” Will their monthly payment change, and who decided?

What a central bank does

A central bank is the bank for banks and the state. It issues the country’s banknotes, holds the accounts of commercial banks, runs payment systems and often supervises banks. You cannot open a savings account there.

Its best-known job is monetary policy: steering the economy, mainly through one short-term interest rate called the policy rate. The ECB’s main policy rate is the deposit facility rate, which is what banks earn on money they leave at the ECB overnight. On 16 September 2026 it was raised to 2.50%.

A thermostat is a useful picture. When prices rise too fast, the central bank raises the rate to cool spending. When the economy is weak, it lowers the rate to encourage spending.

Goals and independence

Each central bank has a legal goal, called its mandate. They differ, as the table below shows. The ECB’s main goal is price stability, which it defines as 2% inflation over the medium term. It treats being below the target as equally unwelcome as being above.

Most democracies make their central banks independent. Elected governments set the goal, and the central bank chooses how to reach it. The reason is that politicians face elections and may be tempted to push rates down beforehand. Evidence from many countries links independence with lower and steadier inflation. Supporters of independence argue that it protects long-term goals. Critics argue that independent bodies need clear accountability to the public. This is a choice made in law, and it is debated openly.

From policy rate to your payment

A rate change spreads in steps:

1. The central bank changes its policy rate.
2. Rates between banks move, such as the one behind Euribor, the average rate at which banks in the euro area lend to each other.
3. Variable-rate loans reprice at their next reset. New fixed rates follow longer-term market rates. Existing fixed rates do not change.
4. Savings rates adjust, often more slowly and only partly. In 2022 and 2023, ECB research found that rates on everyday deposits rose far less than rates on loans and on fixed-term deposits.
5. Borrowing, spending and investment change, then demand and jobs.
6. Inflation changes last. The ECB calls the lags long, variable and uncertain, and the effect often takes a year or two.

Higher rates also tend to strengthen a currency, which makes imports cheaper.

Slovenia inside the Eurosystem

Since 2007, Banka Slovenije no longer sets interest rates for Slovenia. Its governor sits on the ECB Governing Council and votes on euro-area policy. The Eurosystem is the ECB plus the national central banks of euro-area countries. Banka Slovenije still carries out national tasks:

• it supervises the smaller Slovenian banks and takes part in ECB supervision of the largest;
• it makes rules to limit risks in the financial system, such as limits on lending to households;
• it runs the deposit guarantee scheme and handles failing banks;
• it oversees payment systems and puts euro cash into circulation.