Essay: What Causes an Appreciation in the Exchange Rate.

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


Perma Link | By: T Pettinger | Thursday, May 17, 2007
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