The policy rate, also known as repurchase agreement (repo), is an interest rate that the central bank (i.e. Bangladesh Bank) sets. It is usually the rate at which the central bank lends money to commercial banks. It is used to influence the main monetary variables in the economy such as consumer prices, exchange rate etc. Through it, the central bank controls short-term interest rates and the money supply in the economy. It is the price at which private banks obtain money from the central bank. These banks will then offer financial products to their clients at an interest rate that is normally based on the policy rate. Thus the policy rate ultimately determines the levels of the interest rates in the economy.
Policy rate is an important component for central banks. A rise in policy interest rates is commonly used to curb inflation, currency depreciation, excessive credit growth or capital outflows. The rise in the policy rate is likely to make credit costly as banks will have to borrow from the central bank at an increased rate. On the contrary, by cutting interest rates, a central bank might be seeking to boost economic activity by fostering credit expansion or currency depreciation in order to gain competitiveness. The reduced repo rate means banks can get more access to central bank funds at a lower rate of return, thus enabling commercial banks to tackle the impending financial recession.
Reference Article: Bangladesh Bank increases policy rate to 5%