Interest Rates and Central Banks: What Really Moves Currencies

Interest rates are the most important long-run driver of exchange rates: when a central bank raises rates, or markets expect it to, holding that currency earns more, so money flows in and the currency tends to strengthen. But markets move on expectations, so what matters on decision day is the surprise: how the decision and the guidance compare with what traders had already priced in. Knowing each central bank, its calendar and what the market expects is basic preparation for trading any pair.

Why rates move currencies

Imagine two bank deposits: one pays 4% in US dollars, the other 1% in yen. Global investors, pension funds and banks will tend to prefer dollar assets, and to buy them they must first buy dollars. If the gap widens because the Federal Reserve raises rates while Japan holds, demand for dollars grows. If it narrows, the flow slows or reverses.

Two refinements matter:

• Real rates: what investors care about is the rate after inflation. Real rate ≈ nominal rate − inflation. A 10% rate with 15% inflation is a −5% real rate, which is not attractive.
• Relative rates: a currency pair is a contest between two central banks. EUR/USD reflects the European Central Bank and the Federal Reserve.

The eight central banks to know

Currency	Central bank	Decision-making body	Scheduled decisions
USD	Federal Reserve (Fed)	Federal Open Market Committee (FOMC)	8 a year
EUR	European Central Bank (ECB)	Governing Council	About every six weeks (8 a year)
GBP	Bank of England (BoE)	Monetary Policy Committee (MPC)	8 a year
JPY	Bank of Japan (BoJ)	Policy Board	8 a year
CHF	Swiss National Bank (SNB)	Governing Board	Quarterly (4 a year)
AUD	Reserve Bank of Australia (RBA)	Monetary Policy Board	8 a year
NZD	Reserve Bank of New Zealand (RBNZ)	Monetary Policy Committee	7 a year
CAD	Bank of Canada (BoC)	Governing Council	8 a year

Meeting schedules are published a year or more ahead on each bank's website; they occasionally change, and banks can hold unscheduled emergency meetings, as several did in March 2020. Check the current rate and next meeting date for each before trading. For the Pakistani rupee, the State Bank of Pakistan's Monetary Policy Committee plays the same role.

A few features of individual banks:

• Fed: the most influential, because the dollar is on one side of almost nine in ten forex trades. Four times a year it publishes projections that include each official's expected rate path (the "dot plot").
• ECB: sets policy for all euro-area countries at once, so it must balance very different economies.
• BoJ: kept rates at or below zero for many years and capped bond yields; it began raising rates in 2024. Its moves have caused some of the largest yen swings of recent years.
• SNB: has used both negative rates and large currency interventions to stop the franc from strengthening too much, including the minimum EUR/CHF rate it abandoned in January 2015.
• Japan's Ministry of Finance, not the BoJ, decides on currency intervention; the BoJ carries it out. Japan intervened to support the yen in 2022 and 2024.

Expectations and "priced in"

Before each meeting, prices in interest-rate futures and swap markets show what traders expect. Several free tools translate these into probabilities of a hike, hold or cut (for example the CME's FedWatch tool for the Fed). If the market sees a 95% chance of a 0.25% cut, the currency has largely adjusted already. On the day:

Expected	Actual	Typical currency reaction
Cut 0.25%	Cut 0.25%, signals more cuts	Weaker
Cut 0.25%	Cut 0.25%, signals a pause	Stronger
Hold	Surprise hike	Sharply stronger
Hike 0.25%	Hike 0.25%, signals it is the last	Weaker

Beyond the rate: guidance and balance sheets

Central banks communicate through several channels, and each can move currencies:

• The statement: a change of a single word, such as dropping "further tightening may be appropriate", can move a pair 50 pips or more.
• The press conference: tone and answers to questions often matter more than the decision.
• Projections: forecasts for growth, inflation and rates.
• Balance sheet policy: buying bonds (quantitative easing, QE) tends to weaken a currency; shrinking holdings (quantitative tightening, QT) tends to do the opposite.
• Speeches and minutes between meetings.

Risk sentiment and safe havens

Rates explain much, but not everything. In panics, investors buy currencies seen as safe: historically the US dollar, the Japanese yen and the Swiss franc. They sell "risk" currencies such as the Australian and New Zealand dollars and emerging-market currencies. In those moments, rate differentials can be ignored for days or weeks, which is why carry trades crash (see Swaps, Rollover and the Carry Trade).

Trading around central bank decisions

Practical rules:

1. Keep a calendar of every decision for the currencies you hold. See The Economic Calendar.
2. Know what is expected before the meeting, so you can judge the surprise.
3. If you hold through a decision, size the position so a jump of two to three times your stop distance would be survivable.
4. Remember the second currency: a long EUR/USD position is also exposed to the Fed.

Next: the data releases that shape those expectations in The Economic Calendar: CPI, NFP and Trading the News.