The mechanism
Investors comparing a dollar deposit at 5 percent with a euro deposit at 3 percent buy dollars, and the buying lifts the dollar. The effect works through expectations: the market prices the rate path months ahead, so a currency moves when the outlook changes rather than when the bank acts. A rise everyone expected moves nothing on the day; a surprise moves a lot.
Real rates
What matters is the rate after inflation. A 6 percent rate with 5 percent inflation pays less in real terms than 4 percent with 2 percent inflation, and real rate differentials explain currency moves better than nominal ones. High-inflation currencies with high nominal rates often weaken regardless.
Carry and swaps
Holding a high-rate currency against a low-rate one earns the differential daily, which is the carry trade and, on a retail account, the swap. Carry works in calm markets and unwinds violently in scares, when the low-rate funding currencies, the yen and the franc, strengthen.
Reading the market's expectation
Interest rate futures and swap markets show the probability the market assigns to each future decision, and two-year government bond yields track the expected policy path. Comparing two countries' two-year yields is a quick read of where their pair should be heading.
The course module on central banks
Trading forex, CFDs and other leveraged products carries a high risk of losing money. This guide is general education, not advice.