Lesson 2 of 9 · 8 min
Central banks and interest rates
How a rate decision becomes a move in the exchange rate, and why the market often moves before the decision rather than after it.
By the end you'll be able to
- Trace the chain from a rate change to a currency move
- Explain why an expected decision can produce no reaction, or the opposite one
- Read "hawkish" and "dovish" and know what each means for the currency
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Eight times a year, the US central bank announces its interest rate and the whole market stops to listen. What moves the market is usually what it says about the next one.
From the bank to the exchange rate
Step through the chain. Switch to a rate cut to see every arrow reverse.
Every major currency has a central bank that sets a policy interest rate. That rate feeds through to what savers and bond investors earn in the currency, and money moves towards the better return. To earn it, foreign investors must buy the currency first, and that buying is what moves the exchange rate.
The chain works just as well in reverse. Rate cuts lower returns, money leaves, and the currency weakens.
The market moves on expectations
Rate decisions are scheduled and heavily signalled in advance. By decision day, the market has usually already moved to reflect what it expects. If the bank delivers exactly that, the decision is priced in and the reaction can be tiny.
What moves the market is the surprise: a bigger or smaller change than expected, or a statement that is more hawkish or dovish than expected. Hawkish means leaning towards higher rates; dovish means leaning towards lower ones. Markets react to the lean as much as the number.
Try it
| Time | Cur. | Impact | Event | Previous | Forecast | Actual |
|---|---|---|---|---|---|---|
| 19:00 | USD | ●●● | Fed interest rate decision | 4.5% | 4.5% | — |
Slide the actual figure. The market reacts to the gap between actual and forecast, not to the number itself. Reactions are illustrative.
Notice how leaving the actual figure equal to the forecast produces almost no reaction. The market had already moved.
Quick check
Question 1 of 3
Why does a rate rise usually strengthen a currency?
Question 2 of 3
A central bank raises rates exactly as expected and the currency falls. The most likely reason:
Question 3 of 3
A statement described as hawkish suggests:
Go deeper: How interest rates affect currency prices · EUR/USD trading guide · Central Banks and Forex: Fed, ECB, BoE and BoJ Explained · Hawkish vs Dovish: How to Read Central Bank Language