How Central Bank Policy Cycles Shape Currency Trends in 2025

Summary:

Central bank policies in 2025 have had to navigate a storm made of geopolitical tensions and inflationary pressures while balancing the need to set up a suitable environment to create jobs.
While inflation has largely cooled down, employment rate is still relatively high.
Most central banks will likely have limited options to maneuver in 2026.

In 2025, central banks’ varied approaches significantly shaped global currency markets. Interest rate cuts, pauses and cautious strategies created winners and losers. Here’s how the year played out:

Federal Reserve: Easing Policy Pressures the Dollar

The Federal Reserve started 2025 with a slowing job market and cooling inflation. Policy moves like planned interest rate cuts were driven by a desire for a risk management cut, as reported by J.P. Morgan Research.

The Fed’s initial rate cut in September, along with expectations for more cuts into 2026, began an easing cycle, weakening the US Dollar Index (DXY). As of this writing, the DXY index is down by 8.35% year-to-date.

DXY Index daily chart in 2025 has been largely downward. Source: TradingView

By October, the Fed had cut rates twice, bringing the federal funds rate to 3.75%-4.00%. The decisions were influenced by weaker job data and inflation near 2% according to the October FOMC statement. Unemployment was at 4.1%, and consumer spending grew slowly. These moves succeeded in supporting economic activity.

Risks remain high, and as Reuters reported in November, hawks fear inflation resurgence. Over-easing could spark import-price pressure.

European Central Bank (ECB): Pause Supports Euro

The ECB’s 2025 policy focused on bringing inflation back to its medium-term target, as restated in its October bulletin. The Governing Council kept a close watch on data, holding steady after previous cuts, which began in mid-2024. The rate reduction policy went on until June 2025, reducing borrowing costs by 200 basis points.

The ECB paused the rate cutting streak and held the deposit rate at 2% in October. Core inflation stabilised at 2.4%,the ECB noted in its June decision. Growth forecasts rose to 1.2% for 2025.

The pause worked. Eurozone GDP rose steadily, and the euro gained 4% against the US dollar. EUR/USD reached 1.16 by early November, ECB data showed. However, BNP Paribas has warned that trade policy shocks pose the main risk.

EUR/USD daily chart as of November 18, 2025 showing a general upward trajectory. Source: TradingView

Bank of England (BoE): Cautious Stance Lifts the Pound Sterling

The BoE, similar to the ECB, reduced its benchmark interest rate earlier in 2025. The BoE kept the bank rate at 4% in November, as inflation peaked at 3.8% in September before easing. Wage growth slowed to 4%, the September MPC summary stated, with some members pushing for a cut.

The pound sterling rose 2% versus the dollar, as GBP/USD traded near 1.31. Overall, weak growth and potential December easing create uncertainty.

Bank of Japan: Persistent Accommodation Weakens the Yen

The Bank of Japan (BoJ) policy cycle marked a historic shift away from its decades-long ultra loose stance. After ending negative interest rates, the BoJ moved towards gradual normalisation, though still holding rates at 0.5% in late 2025 (through October).

Inflation stayed above 2%, yet Q3 GDP contracted. The central bank’s monetary policy committee minutes revealed concerns over prolonged easing. The yen weakened sharply. USD/JPY approached 145 by December, RBC projected. Depreciation hurt importers, but helped exporters. As a result, currency intervention risks linger. Surging government bond yields, hitting 1.76% in November 2025 according to Trading Economics, signaled the end of the zero-rate era. This move is generally expected to strengthen the Yen as Japanese investors repatriate foreign assets.

Reserve Bank of India (RBI): Dovish Posture to Control the Rupee

The RBI cut the repo rate 100 basis points in early 2025, pausing at 5.50% in October. Inflation hit multi-year lows, while GDP growth exceeded 7% according to RBI’s official statements. With that, the rupee depreciated by just 1% against the dollar. Targeted lending measures supported infrastructure expenditure. However, global volatility remains the key risk.

Overall Global Currency Impact and Outlook

Divergent cycles have driven 2025 trends. The US dollar weakened against the euro and the pound. On the other hand, the yen and several emerging-market currencies lost ground. Looking ahead, J.P. Morgan forecasts EUR/USD at 1.20 by year-end.

Inflation has cooled and growth has held steady. Still, geopolitical tensions and policy mistakes could threaten stability. With these factors in place, central banks will likely start 2026 with limited options.

How did the Fed’s policy affect the US dollar?

Generally, when the Fed started cutting rates, the US dollar index got weaker because the interest rate differences weren’t as good for the dollar.

What was the ECB’s main target for inflation?

The ECB aims to stabilise inflation at 2% rate over the medium term. That will likely guide its interest rate decisions.

What is the Primary Risk of the BoJ’s policy shift?

A major worry is that global markets could get shaky if the Japanese yen carry trade, which many investors use, starts to come undone.

Why did the Fed cut rates twice in 2025?

Because hiring slowed down and inflation was at 2%, the Fed lowered interest rates to help boost employment. By October, the rates were down to 3.75%-4.00%.