OIS Curves Explained: What Markets Price for Future Interest Rates
An overnight index swap, or OIS, exchanges an agreed fixed rate against a payment linked to compounded realised overnight rates. The OIS curve is widely used to examine the market price of future short-term interest rates. It is not a direct survey of central-bank intentions, and forward prices need not equal the market’s most likely policy outcome.
Key takeaways
- OIS contracts reference overnight rates such as SONIA, not a guaranteed future central-bank decision.
- Forward OIS rates incorporate expectations alongside term, liquidity and other risk premia.
- Meeting-by-meeting policy probabilities are model-dependent and need explicit assumptions about possible increments.
- Curve changes can affect FX, bonds, mortgages and equity valuations through different mechanisms.
What is an overnight index swap?
In a plain-vanilla OIS, one counterparty pays a fixed rate while the other pays a rate calculated using the relevant overnight benchmark over the contract period, generally on a compounded basis. The cash flows are netted at settlement under the product’s terms. Currency, business-day and day-count conventions determine exact amounts.
The reference index varies by jurisdiction: sterling markets use SONIA, dollar swaps typically reference SOFR and euro markets use €STR. These overnight rates are not identical to the formal central-bank policy rate, though monetary policy usually influences them. A careful analysis specifies the benchmark and the contracts used.
Reading the shape of an OIS curve
An OIS curve plots fixed swap rates across maturities. A rising curve indicates that longer-tenor fixed rates are above shorter-tenor rates, but it does not prove the central bank will increase rates on a particular date. Forward rates inferred between dates are more directly relevant to the timing of policy changes.
For example, if one segment of a hypothetical forward overnight curve is priced at 4.25% and the following segment at 4.00%, the difference is consistent with some priced reduction in overnight rates. It could also reflect differences in risk premia, fixings, cash-flow conventions and the period boundaries.
From overnight forward pricing to meeting probabilities
A widely used simplified approach assumes a central bank can either leave its policy rate unchanged or cut by 25 basis points at a specified meeting. If the risk-neutral expected change is −10 basis points, a naïve binary calculation yields a 40% cut probability and a 60% hold probability. This is 10 ÷ 25, not a forecast guaranteed by an exchange.
The result requires strong assumptions: exactly two outcomes, a 25-basis-point step, negligible premia and a correct mapping from overnight fixings to policy decisions. Real meetings can surprise in different sizes, timing and communication. The probabilities describe model-implied pricing, not an objective probability supplied by the central bank.
Why the market-implied path can mislead
A 2026 Bank of England analysis examined changes in the UK OIS curve and found that unusually large short-end risk premia could make its slope appear more hawkish than a model of central expectations. This is a concrete reminder that ‘the market expects rates to rise’ can be an overinterpretation of a forward curve.
Liquidity, hedging demand, collateral and model specification all influence fixed swap prices. Survey expectations and term-structure models are useful cross-checks. When describing an implied path, distinguish the quoted curve from an economically adjusted forecast and state when the pricing snapshot was taken.
How to interpret policy surprises
A meeting decision may be exactly the most common forecast yet still move markets if the statement, vote split or projected path changes the price of future meetings. A ‘hold’ accompanied by changed guidance can lift or depress OIS forwards far beyond the overnight tenor.
For market analysis, measure the change in short-end forwards around announcements rather than simply comparing the new policy rate with the old one. Separate target surprises from the expected path, and check whether liquidity was normal during the event window.
Cross-asset transmission
Higher expected overnight rates often change short-dated bond yields and financing costs first. Currency moves depend on rate differentials and expectations in other countries, not only the domestic curve. Long-dated bonds respond to expected future rates, inflation and term premia, potentially in contrasting directions.
Equities may be affected through discount rates, funding costs and earnings prospects. A repricing driven by stronger growth has different implications from one driven by a supply-driven inflation shock. A rates curve is thus a key diagnostic input, not a standalone buy or sell signal.
An OIS research checklist
Capture the overnight benchmark, curve date, day-count, compounding convention, meeting calendar and forward tenors. Compare quoted overnight forwards with policy surveys and official statements. Preserve historical snapshots; using today’s curve to describe what markets expected last month is look-ahead bias.
Run scenarios for 0, 25 and 50 basis-point actions, alternative risk-premium assumptions and changing liquidity. Report conclusions as conditional pricing implications. Mark vendor-generated policy probabilities as estimates and review the underlying methodology before publishing them.
Worked comparison table
| Simplified meeting scenario | Rate action | Assumed market-implied change | Illustrative probability |
|---|---|---|---|
| Hold | 0 basis points | −10 basis points expected | 60% |
| Cut | −25 basis points | −10 basis points expected | 40% |
| Assumptions | Two outcomes only | No risk-premium adjustment | Illustrative, not observed |
Examples are hypothetical and simplified for education; no values represent current market quotes or forecasts.
Frequently asked questions
Is the OIS forward curve a central-bank forecast?
No. It represents market pricing affected by expectations and risk premia.
Does SONIA always equal Bank Rate?
No. It is a transaction-based overnight benchmark that can trade close to but differently from Bank Rate.
Are policy probabilities directly observable?
No. They depend on mapping market prices into assumed outcomes and correcting for market effects.
Why can unchanged policy move bond yields?
New guidance can reprice expectations for future meetings even when the current decision is unchanged.
Sources and further reading
Related Traders MBA guides: Monetary policy transmission and Nominal versus real interest rates.
This article is for educational purposes only, not investment advice or a trading recommendation. Financial markets and derivatives involve risks, including loss.