During 2007, the Euro has appreciated sharply on the back of a falling dollar. Some now consider the Euro as an appropriate heir to the world's dominant currency. There is speculation that OPEC countries will increasingly start to price oil in Euros rather than dollars. Although this is mostly speculation at the moment, if it did occur then it would strengthen the value of the Euro.

The euro is currently trading at about 1 Euro = US$1.42 - staying short of its latest all-time high against the U.S. currency.
When the Euro was launched in 2001, the exchange rate was 1 Euro to 1 Dollar.

The Euro economy is showing signs of renewed growth, with subdued inflation. Economic growth is currently a steady 2.5% with inflation right on target at 2%. This creates a good economic environment for a strong currency. With inflation under control, the ECB can maintain low interest rates and allow the economy to expand. However, if growth picks up next year, interest rates could continue to remain higher than US interest rates, this will could cause a further appreciation. Interest rates are currently 4.66%

There have been concerns that the appreciating Euro is causing hardships for European exporters, but at the moment demand is proving to be quite inelastic and not particularly sensitive to changes in the currency. If anything European exporters are proving resilient in maintaining export sales.

• Forecast for US Dollar
• Reasons for fall in US dollar
• Exchange Rates
  

Labels: exchange rates

I have written frequently about the decline in the US Dollar.

• Reasons for Fall in US Dollar
  
• Predictions for US dollar 2008

Mirroring the decline in the US Dollar, the Canadian Dollar (nicknamed the Loonie, after the bird that appears on coins) has experienced a significant appreciation.
The strength of the Canadian dollar is due, not just to a falling US dollar, but also the strength of its exporting raw material sector.

I have written here about The future prospects for the Canadian dollar

Labels: exchange rates

what's likely to happen to the value of the pound over next few years? What'd happen if there was a crash in the housing market, for example? Or if the dollar continued to drop?

Interesting Question.

Firstly: Factors that influence Exchange Rates

1. Interest Rates
2. Competitiveness of British Goods
3. Confidence / expectations of investors

Factors that influence Forecast for Pound Sterling

• House Price Crash? - It is quite likely there could be a fall in house prices. If this was to occur we would see a significant fall in consumer spending growth. This lower spending would reduce inflationary pressures and enable the MPC to cut interest rates. Lower Interest rates could reduce the value of the pound. (less people want to save in UK banks)
• Continued Weakness of the Dollar - It the dollar depreciates further against the pound - which is quite likely, the pound will continue to rise against the dollar, but, our main trading partner is the EU. Therefore, the key question is will the Pound rise or fall against the EURO (66% of trade is with EU, 16% with US)
• The Pound is Overvalued - According to the Big Mac index the Pound is at least 21% overvalued against the US dollar. The Big Mac reflects purchasing power parity and this shows that the strength of the pound has meant that British goods are more expensive. - Just go to America and see how much cheaper electronic goods are.
• However, the Big Mac index is a very poor guide to future currency movements. Currencies can often remain overvalued permanently. For example, the Yen has been overvalued for several years.
• Comparison with Other Countries - 2008 could see UK interest rates fall, however, if European and US interest rates fall by the same rate there will be no downward pressure on the Pound.
• Balance of Payments - Current account deficit in the UK is about 3%. A large current account deficit can contribute to a devaluation. - The US deficit is 6% of GDP and is a factor in the dollar's devaluation
• Market Sentiment - This one is very difficult to predict. Generally, the Pound has been seen as a reasonable investment. The UK economy is doing relatively well and we have a good record of low inflationary growth. I can't see this changing fundamentally.

Conclusion

I think it is likely that the pound will remain overvalued on PPP measures such as the Big Mac Index. The UK economy may slow down next year, however, at the moment, I cannot see a serious crash. The slowdown is unlikely to be any more serious than our trading partners. Therefore, the pound will continue to be strong especially against the dollar.

Labels: exchange rates

Assess the likely implications of a devaluation in the dollar. (12)

Should we concerned about a rapid devaluation in the dollar?

Benefits of devaluation

Economic Growth

If the dollar becomes weaker, exports become cheaper leading to an increase in demand for US exports. This can help to increase AD and improve the rate of economic growth. This may be important, because problems in the US housing market are threatening the rate of economic growth. Falling house prices are potentially reducing consumer spending, therefore, a rise in exports could help to boost economic growth and prevent any move towards a recession.

Balance of Payments.

The US has a large current account deficit (7% of GDP) therefore a devaluation will help to improve and reduce the current account deficit. However, a devaluation alone is unlikely to solve the problem. Also, there is evidence that demand for exports and imports is relatively inelastic; therefore, any devaluation will have a small impact on the value of exports and imports. It is argued that the fundamental reason for a deficit is the low levels of domestic savings and consequently high levels of consumer spending.

Inflation

A devaluation may lead to increased inflationary pressures for 3 reasons:

1) Increase in exports causes rising AD and therefore could lead to demand pull inflation.
2) Imported goods will be more expensive. American consumers would definitely experience a rise in price for many imported manufactured goods and imports of raw materials could increase costs of business.
3) It is argued a devaluation reduces the incentive, for manufacturers and exporters, to cut costs and become more efficient.

However, the impact of a devaluation depends on the state of the economy. As previously mentioned, the US economy is slowing down; therefore inflationary pressures are subdued and therefore inflation is unlikely to occur.

• Will the US dollar continue to fall?

Labels: exchange rates, US economy

examine the possible factors which might have lead to changes in the value of the pound sterling against the euro in recent years.(40)

Let us assume the £ has appreciated against the Euro. Why would the £ appreciate:

Basically it involves more demand for Sterling:

1. Higher interest rates in the UK. This makes it more attractive to save in the UK, causing hot money flows
2. Lower inflation in the UK. This makes British goods comparatively more competitive, increasing demand.
3. Increased productivity and attractiveness of goods.
4. Speculation. People feel the £ is likely to appreciate in the future
5. Current account surplus. not actually the case, but it would be more likely to cause an appreciation

View:

• Factors influencing exchange rate
• will the dollar continue to fall?

Labels: exchange rates

Evaluate the impact of a sustained rise in the value of the Chinese Currency (Renminbi) against the dollar?


If The value of the Chinese currency increases, it will mean it is cheaper for Chinese consumers to import from abroad. It will make Chinese exports relatively more expensive.

The US currency will be weaker and therefore it will be more expensive for American consumers to buy imports from China.

Therefore this may lead to a reduction in the Chinese current account surplus and a reduction in the US current account deficit. This is because Chinese exports become less competitive and so will import less from China.

However, it depends upon the elasticity of demand for imports and exports. For example, if US demand for Chinese exports is inelastic, then an increased price of exports will not reduce their value. Also, the US may simply switch to buying these imports from related Asian economies.


Benefits of an Appreciation in the Chinese Currency

1. Improvement in current account deficit
China's trade surplus with America was $233 billion in 2006, this is almost 30% of America's total deficit. However, the improvement in the deficit may be much smaller than anticipated. A revaluation will not tackle underlying problems of low US savings and changing comparative advantage

2. Help Reduce Chinese Inflation.
Higher exchange rate will help reduce inflationary pressures in China for 3 reasons;

• Lower AD falling Exports (Exports is a big component of Chinese AD)
• Price of Imported goods is cheaper.
• Chinese exporters have greater incentive to cut costs and increase efficiency. This can benefit the economy in the long run.

this is important, because the Chinese economy is growing above 10% per annum. (11.1%) most recent. There are concerns this could lead to inflationary pressures. An appreciation will help to moderate growth; in particular reduce the investment and borrowing boom, which results from low interest rates

3. Help economic growth and reduce unemployment in US.

It is argued that many American exporters are losing out to Chinese firms. If the Chinese Renminbi was revalued, it would allow an increase in demand for US good. This could be important with American growth slowing. However, American politicians exaggerate the impact of a low Chinese currency on the US economy. Firstly, US unemployment is quite low at 4.5% and the US trade deficit is merely a reflection of the low US savings ratio (and high consumer spending) if the deficit wasn't with China it would be with somebody else.



Problems of an appreciation

1. Could lead to lower economic growth in China

An appreciation will reduce economic growth, this could exacerbate the problem of unemployment resulting from privatisation. This is the main reason the Chinese government is reluctant to revalue. However, with growth of 10%, maybe they do not have the right priorities. Even though Exports are the main determinant of growth, an appreciation is unlikely to cause any serious damage to economic growth. A slightly lower growth rate would have several advantages, primarily low inflation.

See also:

• Exchange Rates

• China and US currency at Economist.com

Labels: Chinese economy, exchange rates

1. The £ is stronger therefore, exports are more expensive to buy. More foreign currency is needed to get the same amount of British goods

2. Imports will be cheaper.

3. Therefore, we will get a rise in the quantity of imports and a fall in quantity of exports.

4. Assuming demand is relatively elastic this will cause a fall in the value of exports and rise in value of imports.

5. AD = C + I + G + X - M. Therefore, a fall in exports and rise in imports will reduce AD, or lower the growth of AD.

6. A fall in AD will cause a lower rate of economic growth and a lower rate of inflation.

7. A fall in exports and rise in imports will lead to a worsening of the current account, e.g. deficit will get bigger.


Evaluation of an appreciation

1. Does on State of Economy.

If economy is growing rapidly and is close to full capacity then an appreciation can help to reduce inflationary pressures.

2. The exchange rate is only a small factor affecting AD. For example, the UK has seen an appreciation in the exchange rate, but the MPC has needed to increase interest rates 4 times in the past 8 months to control inflationary pressures.

3. Depends on other factors affecting AD.

E.g. Rising house prices have led to rising consumer confidence and therefore growth in the UK has been strong, despite an appreciation in the £.

4. Depends on Elasticity of demand.

If demand is inelastic, an appreciation in the exchange rate will cause a rise in AD and improvement in the current account. However, it is rare for demand to be inelastic, at least in the long run.

5. An Appreciation can reduce inflation.

Lower AD - less demand pull inflation
Cheaper imports - lower cost push inflation
Increased incentive for exporters to cut costs and become more efficient. Helps reduce cost push inflation.

related essay:

• Discuss effects of Increase in interest rates

Labels: exchange rates

An appreciation means the exchange rate (£) becomes stronger against a basket of currencies.

The £ will become stronger if there is higher demand, or lower supply of sterling.

Reasons for an appreciation in the Exchange Rate

1. Increase in Interest Rates.

Higher interest rates make it more attractive to save in the UK. Therefore, there will be an inflow of hot money (people holding currency in UK saving accounts. This increase in demand for sterling causes the appreciation.

2. Lower Inflation.

Lower UK inflation makes UK goods more competitive against foreign goods. Therefore, there will be more demand for British goods and hence sterling. This is a long term factor.

3. Increased competitiveness of UK goods.

Increased productivity and greater competitiveness will make British goods more attractive.

4. Expectations

Speculation plays an increasing role in the determination of exchange rates. If investors feel a currency is likely to appreciate in the future they will buy now and actually make it occur. E.g. if people expect interest rates to rise the currency will rise.

5. Surplus on Current Account.

This causes an inflow of foreign exchange into the economy

• Exchange Rates

Labels: exchange rates