Tightening the screws: are rising interest rates actually working?

The economic environment has shifted markedly over the last couple of years. Inflation in most advanced economies has soared to historic highs and, as a result, central banks have tightened monetary policy forcefully – principally through raising interest rates. In this note, we outline how rising rates feed through to activity, financial markets and ultimately to inflation.

It is clear from our analysis that the economic conditions within which changes in monetary policy occur have a profound bearing on its effectiveness – i.e. “state dependency”. The myriad of global shocks over the last couple of years – such as the COVID-19 pandemic, war in Ukraine and supply chain disruption – may have influenced just how long higher rates are taking to feed through to the economy. In the UK in particular, there is growing evidence to suggest that while the pass-through is happening as expected, it is taking longer.

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