How inflation, interest rates and bond yields fit together

The terms you need

Each definition is followed by a real example from the latest data.

Inflation

How fast average consumer prices are rising, measured as the change in the consumer price index (CPI) compared with the same month a year earlier.

Example: UK inflation was 3.5% in September 2026, so a basket of goods that cost £100 a year ago now costs about £103.50.

Core inflation

Inflation without the most volatile prices, mainly energy and food. It shows the underlying trend that central banks watch most closely.

Example: US headline inflation is 3.7%, but core is only 2.6%, so most of the rise comes from energy and food.

Inflation target

The inflation rate a central bank aims for over time. The Fed, ECB, Bank of England and Bank of Japan all target 2%.

Example: Euro area inflation at 3.8% is almost double the ECB’s target.

Central bank

The public institution that sets a country’s short-term interest rates and oversees its money and banking system. In most advanced economies it is independent of the government.

Example: The Federal Reserve (US), ECB (euro area), Bank of England, Bank of Japan and People’s Bank of China.

Policy rate

The short-term interest rate a central bank sets. It anchors what banks pay to borrow from each other overnight, and from there flows into loan and savings rates. Its name differs by country.

Example: The Bank of England’s policy rate is called Bank Rate, currently 3.75%.

Government bond

A loan to a government. The buyer pays a price today, receives a fixed interest payment (the coupon) every year, and gets the face value back when the bond matures.

Example: Treasuries (US), Bunds (Germany), OATs (France), gilts (UK), JGBs (Japan), CGBs (China).

Bond yield

The annual return a buyer earns by purchasing a bond at today’s price and holding it to maturity. When a bond’s price falls, its yield rises. The 10-year yield is the benchmark for mortgages and long-term business loans.

Example: The US 10-year Treasury yield is 5.14%.

Real interest rate

An interest rate minus inflation. It shows what borrowing really costs once rising prices are taken into account.

Example: ECB rate 2.50% − euro area inflation 3.8% = a real rate of −1.3%.

Term premium

The extra yield investors demand for locking their money up for many years, on top of what they expect short-term rates to average. It compensates for uncertainty about inflation and government finances.

Example: If investors expect the policy rate to average 4.0% over the next ten years and the 10-year yield is 4.5%, the term premium is about 0.5 points. It can’t be observed directly, so economists estimate it with models.

Basis point (bp)

One hundredth of a percentage point, used for small moves in rates and yields. 25 bp = 0.25 percentage points.

Example: The US 10-year yield has risen 101 bp since February, from 4.13% to 5.14%.

Five links in the chain

When inflation surprises, the effect travels through the economy in a fairly predictable order. Bond markets usually react before the central bank acts.

1. 1 →Inflation surprisePrices rise faster than expected. Headline moves first; it matters more if core follows.
2. 2 →Central bank reactionThe bank raises, or signals it will raise, its policy rate to cool demand.
3. 3 →Expected rate pathMarkets reprice where short-term rates will sit over the next several years.
4. 4 →Long-term yieldsThe 10-year yield rises with expected rates, plus extra compensation for risk.
5. 5The real economyMortgages, corporate loans and currencies reprice; demand slows with a lag.

Two outside forces push on the chain

Where the five economies stand

This mechanic in the news

Recent stories that show this mechanism at work, newest first.