Question: Explain what could cause a rise in the value of the £.
The £ will rise if relative interest rates increase in favour of the Uk. A rise in the UK’s relative interest rate means UK banks give a higher return than foreign banks, this incentivizes foreign agents to save more in the UK, demand for the £ rises so the £ rises.
Additionally, the £ will rise if relative inflation rates move in favour of the UK. Purchasing power parity (PPP) means the market exchange rate between two countries equals the ratio of the two country’s prices for the same bundle of goods. Market exchange rates are influenced by the purchasing power of currencies. If the UK’s inflation is lower than Spain’s then the same bundle of goods in the UK now costs less than in Spain, Spanish consumers buy more £ to buy the cheaper bundle of goods from the UK, and demand for the £ rises and until PPP is restored.
Another factor that will cause the value of the £ to rise is a boom in the foreign economies. A boom in the USA means that the USA’s consumers’ income rises and they buy more domestic and foreign goods and services, so their imports rise. If they buy more goods from the UK then demand for £ rises and sterling becomes stronger. of the £ rises so the XR falls.
Moreover, the £ will rise if there is an influx of multinational companies and foreign direct investment into the UK. If more multinational companies set up production in the UK they must buy the £, causing demand for the £ to increase.
Lastly, the value of sterling could increase due to speculation. A major determinant of short-term movements in exchange rates is speculation. Agents may trade currencies to make a profit by buying low and selling high. If agents expect a currency to rise they will buy that currency while the price is low and sell it after its value has risen to make a profit. Speculation that the £ will appreciate means speculators will buy the £, there is an inflow of ‘hot money’ into the UK and the value of the £ rises.