Mortgage holders know interest rates have risen over the past year. But they’re not alone: governments and business borrowers are facing the same pressure.

In the United States, 10-year interest rates sit around 4.7%, surging nearly half a per cent just this year, while the benchmark 30-year bond is near a two-decade high. In the UK, 10-year bond rates on Tuesday hit the highest level since the global financial crisis.

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In Australia, the Reserve Bank of Australia also lifted the cash rate to fight inflation. That government now has to offer investors more than 5% on its 10-year bonds, which hit a 15-year high on Tuesday after a long period of low interest rates since the global financial crisis in 2008.

Higher rates mean higher interest payments for governments too, leaving less room for other spending or for tax cuts. This trickles down to state and local communities.

So what’s actually driving market interest rates higher?

Supply and demand

Governments issue bonds to raise money and finance spending that isn’t covered by tax revenue.

Like any asset, the price of a government bond depends on supply and demand. Less bond supply means issuers (governments or companies) don’t need to offer higher rates to attract buyers; more supply pushes rates up.

Bond issuance comes from three main sources:

• Households – borrowing for mortgages, which the banks can then repackage into bonds and sell to investors.
• Businesses – issuing bonds to fund operations. In the U.S., AI-sector firms such as Amazon and Microsoft have issued about $240 billion in debt to fund data centers. Even in Australia, Google owner Alphabet launched a huge A$5.5 billion bond last month.
• Governments – governments often have large debts they have built up because of their past budget deficits. Like anyone, if you spend more than you earn, you need to borrow.

The main driver is government debt

The larger a government’s debt, the more bonds it must issue — and the higher the interest rates needed to attract investors.

U.S. national debt has grown to more than $40 trillion — more than 20 times the size of Australia’s entire economy — while Australia’s federal government debt recently passed A$1 trillion.

Funding debts of this size is pushing up interest rates worldwide. At the same time, bond investors are getting concerned by the high levels of U.S. government debt and the lack of plans to curb spending, so they are demanding higher interest rates on government bonds.

What central banks can do

The Reserve Bank of Australia manages interest rates through the “cash market” — short-term borrowing of less than a day — using the cash rate to influence demand for borrowing. Raising interest rates ultimately dampens economic demand and reduces inflation.

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The RBA cash rate affects borrowing costs across the economy for all other forms of debt, including car loans and credit cards as well as mortgages, and corporate debt.

But the RBA can’t directly influence longer-term interest rates such as 10-year bonds, which are market rates and fluctuate constantly based on investor demand.

If the RBA cut rates sharply right now, for instance, bond investors would likely read this as inflationary — pushing up inflation expectations and, in turn, the interest rates demanded on longer-term bonds. The RBA’s action would end up being counterproductive.

America’s ‘exorbitant privilege’ — and its limits

The United States has long enjoyed a unique position in global markets: it can issue growing volumes of government bonds without needing to offer higher rates to attract buyers.

This “exorbitant privilege” stems from the U.S. dollar’s dominance in global trade and financial transactions, and the widespread trust that central banks and private investors place in U.S. government debt.

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U.S. Treasury Secretary Scott Bessent has tried to capitalize on this by intervening in the bond market, aiming to shrink supply and push market interest rates lower. That would reduce the interest bill for the U.S. government.

The U.S. Treasury increased the amount of debt it is buying back, but the buybacks only had a brief impact on the market.

Investors concluded the buybacks don’t change the underlying picture: increasing U.S. government financing needs, fears of rising inflation, as well as growing corporate bond issuance to fund AI and data centers. All these forces tend to push interest rates higher over the medium to long term, and no financial engineering can undo this reality.

Rates are rising around the world

Across many countries, bond market rates are rising because higher inflation is eroding the real returns for investors. They are demanding more compensation to protect their spending power.

This is compounded by rising bond issuance from both governments and companies. No amount of financial engineering from the U.S. Treasury can reverse these forces.

Central banks and governments can influence short-term interest rates to some degree. But longer-term debt such as 10-year bonds are ultimately priced on three things:

• Expected inflation
• The scale of government debt and financing needs
• The level of corporate and household borrowing.

The best thing any central bank can do to keep market interest rates low is set policy so inflation remains low.

That’s the purpose of the RBA’s inflation target of 2–3%. As well as keeping a lid on consumer inflation expectations, it lets bond investors know inflation should return to that level in the medium term, and so market interest rates don’t get too high.

This article is republished from The Conversation under a Creative Commons license. Read the original article.

Mark Crosby is a professor at Monash Business School, Monash University. Through its opinion section, Kansas Reflector works to amplify the voices of people who are affected by public policies or excluded from public debate. Find information, including how to submit your own commentary, here.