How do bond yields affect interest rates?

Bond yields are the market's price for lending to a borrower over a given term. When investors demand higher yields on government bonds, those yields become the baseline for many other interest rates across the economy. Central banks set short term policy rates to influence economic activity, but market bond yields reflect expectations about future policy, inflation, and risk, so changes in yields pass through to mortgage rates, corporate borrowing costs, and consumer loans.

How Yields Shape Borrowing Costs
Long term yields serve as a reference point for lenders and borrowers. Mortgage lenders price loans off long term government yields plus a risk margin. Corporations issue bonds and set loan terms based on comparable government bond yields and perceived credit risk. Frederic S. Mishkin Columbia University explains the term structure of interest rates as reflecting expected path of short term rates and a term premium that compensates investors for uncertainty. Ben S. Bernanke Brookings Institution has emphasized that movements in long term yields often reflect changing expectations about future central bank action as well as shifts in risk appetite. When yields rise, borrowing costs for households and firms typically increase, slowing consumption and investment. When yields fall, financing becomes cheaper, supporting spending and asset prices.

What Drives Bond Yields
Several forces determine yields simultaneously. Expected inflation raises nominal yields because investors demand compensation for the loss of purchasing power. Real economic growth and anticipated central bank tightening push expected short term rates higher, which lifts long term yields through expectations. Term premia fluctuate with uncertainty about future inflation and growth and with supply and demand for safe assets. Olivier Blanchard International Monetary Fund has analyzed how global savings and demographic trends have contributed to lower equilibrium real interest rates in many advanced economies. Central bank balance sheet policies and large scale asset purchases can compress yields directly by increasing demand for government bonds, while fiscal deficits and heavy issuance can push yields up.

Consequences and Local Nuances
The pass through from bond yields to broader interest rates has tangible consequences for households, firms, and governments. Higher yields raise mortgage payments and can slow housing market activity in countries with high homeownership, affecting household wealth and consumption. Corporations facing higher financing costs may delay investment, with implications for employment in industrial regions. Emerging markets and small open economies are particularly sensitive to changes in global yields; capital flow reversals can force abrupt policy adjustments and currency depreciation. Environmental and territorial considerations appear when yield levels affect the cost of financing green infrastructure, influencing the pace of climate adaptation projects in low income areas. Policymakers must balance controlling inflation and maintaining manageable borrowing costs, a tradeoff that links bond market dynamics directly to economic and social outcomes.