When a central bank changes its policy rate, it does not directly set the interest rate you pay on a mortgage or a business loan. Instead, it sets the overnight interbank rate and relies on a chain of transmission to reach the real economy. Understanding this chain is what separates a trader who reacts to headlines from one who anticipates second-order effects.

The transmission mechanism operates through several channels:

Interest rate channel: Policy rate → money market rates → bank lending rates → borrowing & investment decisions.
Credit channel: Higher rates reduce collateral values, tightening bank lending standards and shrinking credit availability.
Asset price channel: Rate changes alter discount rates, repricing equities, bonds, and real estate.
Exchange rate channel: Higher domestic rates attract foreign capital, appreciating the currency and lowering import prices.
Expectations channel: Forward guidance shapes what markets expect future rates to be, which matters more than the current rate itself.

Channel	Speed	Typical Lag
Money markets	Immediate	Minutes to hours
Bank lending rates	Fast	Days to weeks
Business investment	Slow	2–4 quarters
Inflation (CPI)	Slowest	4–8 quarters

The practical takeaway: markets price the expected path of rates, not the current level. A 25bp hike that is fully priced in may cause equities to rally if the accompanying statement signals the hiking cycle is near its end.