Central banks and interest rates: how they move currencies and markets

Central banks set the price of money. When they change their key interest rate, or simply hint that they might, currencies, bond yields, stock indices and gold can move within seconds. For a trader, understanding central banks is the shortest way to understand why markets move. This guide explains how they work, what to watch on decision day and how to follow the seven central banks that matter most.

What a central bank does

A central bank’s main task is to keep prices stable: most target inflation of about 2% over the medium term. Some have a wider mandate: the US Federal Reserve must also aim for maximum employment. Their main tool is a key interest rate, the rate at which commercial banks borrow from or deposit money with the central bank. It feeds through to the rates on loans, mortgages and savings across the economy.

• When inflation runs too high, the central bank raises its rate to slow borrowing and spending.
• When the economy weakens and inflation is low, it cuts its rate to support activity.

How a rate decision moves markets

Market	Higher rates (or expected to be)	Lower rates (or expected to be)
The currency	Usually rises: money flows to where it earns more	Usually falls
Bond yields	Rise	Fall
Stock indices	Often under pressure: borrowing costs more	Often supported
Gold	Often under pressure: it pays no interest	Often supported

These are tendencies, not rules. The reaction depends above all on what the market expected.

Expectations matter more than the decision

Markets price in the expected decision weeks in advance. A rate hike that everyone expected can leave the currency unchanged, or even weaken it if the central bank hints that it is the last one. What moves prices is the surprise: a decision, a tone or forecasts that differ from expectations.

• Hawkish: more worried about inflation, inclined to keep rates high or raise them. Usually supports the currency.
• Dovish: more worried about growth, inclined to cut. Usually weighs on the currency.

What happens on decision day

1. The decision and the statement: the new rate and a short explanation.
2. The press conference: the governor or president answers questions. Markets listen for any hint about the next meetings.
3. Forecasts, at some meetings: growth and inflation projections. At the Fed, the “dot plot” shows where each member expects rates to go.
4. The vote, at some central banks: at the Bank of England, the split of the nine votes is published with the decision.
5. The minutes, a few weeks later: a summary of the discussion.

The minutes around the announcement and the press conference are often the most volatile of the day on the currencies concerned.

The data central banks watch

Central banks decide based on data, so the data move markets too:

• Inflation: the consumer price index and core inflation. See inflation and the CPI.
• Jobs and wages: a tight labour market can push inflation up. See the US jobs report.
• Growth: GDP and business surveys (PMI).

All these releases are in our economic calendar, with the forecast and the previous figure.

How rate gaps move currency pairs

A currency pair compares two currencies, and so two central banks. What drives the pair is the gap between their rates, and how that gap is expected to change. When the Federal Reserve is expected to keep rates high while the European Central Bank cuts, the dollar tends to gain against the euro and EUR/USD to fall. When the Bank of Japan keeps its rate far below US rates, the yen tends to be weak against the dollar. See our EUR/USD guide for a worked example.

The seven central banks that matter most

Central bank	Currency	Key rate	Decision time	Meetings a year
Federal Reserve	USD	Federal funds target range	14:00 New York	8
European Central Bank	EUR	Deposit facility rate	14:15 Frankfurt	8
Bank of England	GBP	Bank Rate	12:00 London	8
Bank of Japan	JPY	Policy rate	Around midday Tokyo, no fixed time	8
Swiss National Bank	CHF	SNB policy rate	09:30 Zurich	4
Bank of Canada	CAD	Policy rate	09:45 Ottawa	8
Reserve Bank of Australia	AUD	Cash rate target	14:30 Sydney	8

The Federal Reserve moves the most markets: the dollar is on one side of most currency trades, and US rates influence gold and stock indices worldwide.

Follow central banks with Optencis

• Central bank meetings: the current rate of each of these seven banks and a countdown to the next decision.
• Our pages on the Federal Reserve, the European Central Bank and the Bank of England: meeting dates, what to watch and our latest articles.
• Our preview the day before each major decision, and our article on the decision, in the News.
• Optencis Wire: when a decision surprises the market, members receive a short-term trade idea based on it.

Frequently asked questions

What is a central bank’s key interest rate?

The rate at which commercial banks borrow from or deposit money with the central bank. It guides the rates on loans and savings across the economy.

Why does a rate hike usually strengthen a currency?

Because higher rates make it more attractive to hold that currency: savings and bonds in that currency pay more. The effect depends on whether the hike was expected.

What do hawkish and dovish mean?

Hawkish describes a central bank more worried about inflation and inclined to keep rates high; dovish, one more worried about growth and inclined to cut.

Which central bank moves markets the most?

The US Federal Reserve, because the dollar is involved in most currency trades and US rates influence gold and stock markets worldwide.

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