When interest rates rise or fall, why do currencies and gold move?

The policy interest rate is one of the biggest drivers of currencies and gold, because it decides how much you earn for holding a currency. But what makes price jump on announcement day is usually not the rate itself. It is the gap between what was announced and what the market expected.

What is the policy rate?

The policy rate is the interest rate each country’s central bank uses as its main tool to manage inflation and the economy. Examples include the US Federal Reserve (Fed), the European Central Bank (ECB), the Bank of Japan (BoJ) and the Bank of Thailand.

The broad idea:

• When inflation is above target, central banks tend to raise rates, making borrowing more expensive and slowing spending
• When the economy slows, central banks tend to cut rates, making borrowing cheaper and encouraging spending

The policy rate feeds into deposit rates, bond yields and, overall, the return for holding that currency.

Why interest rates move currencies

Money tends to flow toward better returns when the risk is similar. Here is a made-up example.

• 100,000 held in a currency paying 5% a year earns 100,000 × 0.05 = 5,000 a year
• The same amount in a currency paying 1% a year earns 100,000 × 0.01 = 1,000 a year
• The difference is 4,000 a year

If other risks are about the same, investors would rather hold the 5% currency. Demand for it rises, and the currency tends to strengthen. A currency whose rate is falling or lower tends to do the opposite.

The key point: a currency pair compares two currencies. EURUSD doesn’t move on US rates alone. It moves on the gap between European and US rates. If both sides raise rates by about the same amount at the same time, the gap barely changes, and the effect on the pair may be small.

Markets react to the surprise, not the number

Before each meeting, analysts and the market already have a view on what the central bank will likely do. So price often moves ahead of time. Traders call this priced in: the price already reflects what was expected.

What happens	What you often see
Decision matches market expectations	Price may move little, or swing briefly and come back
Bigger hike than expected, or a more hawkish signal than expected	That currency tends to strengthen
Smaller hike than expected, or a more dovish signal than expected	That currency tends to weaken

Beyond the number, the market also listens to the statement and the press conference after the meeting, because they hint at the direction of future meetings. Often price moves harder during the press conference than when the number comes out.

If rate news comes out and price doesn’t move the way the textbook says, the market isn’t wrong. It usually means the market had already expected it.

How gold relates to interest rates

Gold pays no interest and no dividends. So holding gold has an opportunity cost: the return you would have earned by holding an interest-paying asset with that money instead.

• When rates rise, the opportunity cost of holding gold rises, and gold often comes under pressure
• When rates fall, the opportunity cost drops, and gold often gets support

Many people also watch the real interest rate: the interest rate minus inflation. A made-up example: rates at 4% and inflation at 3% give a real rate of 4 − 3 = 1%. If rates stay the same but inflation rises to 5%, the real rate becomes 4 − 5 = −1%. Holding cash then loses real value, which is a setting that often favours gold.

Another point: gold on the world market is priced in US dollars. When the dollar strengthens, gold becomes more expensive for buyers holding other currencies. So gold often moves opposite to the dollar, but not every time.

All of these relationships are tendencies, not fixed rules. Gold also moves on other factors, such as market fear that sends people to safe-haven assets, and buying and selling by central banks themselves. So at times gold and interest rates can rise together.

How to use this when trading

You don’t need to guess the outcome of a meeting, but you should know when it is happening.

1. Check the economic calendar every week. Look for rate meeting dates for the currencies you trade, and for the US if you trade gold.
2. Look at the forecast. Most calendars have a forecast column, so you know what counts as “as expected” and what counts as a “surprise”.
3. Be ready for wider spreads. When major news comes out, spreads often widen and price can jump. Your Stop loss may be filled at a worse price than you set.
4. Decide in advance whether you will hold an order through the news, then stick to it. Don’t decide while price is spiking.

Common mistakes

• Looking at one country’s rate and forgetting that a pair always compares two sides.
• Believing a rate hike = an instantly stronger currency, when the market may have already expected it.
• Opening a big order before the news to guess the direction. The risk is much higher than on a normal day, because price can spike both ways before picking a direction.
• Drawing a conclusion from one event, as if this kind of news always sends price the same way.