The effective exchange rate measures the value of a currency against a basket of other currencies. This exchange rate index is usually trade-weighted to take into account the relative importance of other currencies.
When looking at the effective Sterling exchange rate we will compare the value of Sterling against our main trading partners – The Euro, the Dollar, the Yen e.t.c and give a weighting depending on how much we trade with that currency, e.g. Eurozone 60%. A weighting will be given to different trading countries depending on how significant they are.
An appreciation in the Sterling effective exchange rate means that on average the UK currency is increasing in value against our main trading partners.
See also: Real exchange rates
Sterling exchange rate index
This is the Sterling exchange rate index since 1980. Some interesting points on the graph:
- 1980 – sharp appreciation in Pound due to high interest rates and increased oil production in the North Sea.
- 1980-1984 – sharp depreciation in Pound Sterling due to deep recession of 1980/81 and subsequent cut in interest rates.
- 1992 – Devaluation of Pound as UK leaves the ERM – UK unable to maintain high value of currency because high interest rates were causing deep recession.
- 2008 – Sharp depreciation in the Pound as the UK economy was hit hard by the financial crisis and recession. Interest rates cut to 0.5%
- 2013-2015 – Increase in the value of the Pound as the UK economy recovery compares favourably to the rest of the Eurozone – making it likely interest rates will rise sooner in the UK than Eurozone.
Sterling index since 20005
Recent Sterling changes in more detail.
Euro exchange rate index
- Approx 30% rise in value of Euro from the start of the Euro in 2000 to Dec 2007.
- Approx 20% decline in value of Euro since financial crisis and Eurocrisis of 2009-12. Recent fall in Euro as the Euro-economy looks to be weak – low growth, high unemployment and likelihood of low interest rates for considerable time.
Euro exchange rates before Euro
A look at three European exchange rates before the creation of the Euro.
- Spanish and Greek currency underwent large depreciations in this period.
- The German currency appreciated considerably. (though reunification in 1990s caused some depreciation)
- This large divergence in exchange rates foreshadows the significant exchange rate imbalances in the Eurozone. Problems of Euro.
Dollar exchange rate index
- The long and persistent depreciation in the dollar 2001-2011 (approx 35%) has been reversed since 2012, as the US economy shows signs of economic recovery and probability that interest rates will rise at some point in the future.
- The remarkable appreciation in the value of the Yen from mid 1970s to mid 1990s reflects the superior Japanese long-term competitiveness. By increasing productivity and becoming more competitive (relative lower inflation, relatively higher productivity), the Yen has increased in value.
- Period of stagflation in 1990s and 2000s, put an end to the appreciation.
- Rise in 2008-10 due to Japan being less affected by financial crisis. Japanese interest rates were already close to zero, so with other economies also having low interest rates, there was less demand for saving abroad.
- Since 2011, Japanese Yen reversed gains – falling approx. 30%. This was partly due to Abenomics – looser monetary policy and expansion fiscal policy with an aim to increase inflation and economic growth
- Latest Sterling exchange rates at Bank of England