Exchange Rate

Exchange Rate



Exchange Rate

An exchange rate is the value of one currency expressed in terms of another. So £1 may be worth $1.55 and €1.33.

A currency that is getting stronger or appreciating is a currency that is going up in value against another. So £1:$1.5 moving to £1:$1.8 means the pound is getting stronger

A currency that is becoming weaker or depreciating is a currency that is going down in value against another. So £1:$1.8 moving to £1:$1.5 means the pound is getting weaker

Currencies change in value against each other all the time. This is because most currencies are based on flexible exchange rates. The notable difference is in the Euro zone (see below).

Currencies change in value because there is a change in demand for holding that currency. Households, governments and businesses need other countries currencies to buy their goods and services (e.g. holiday makers for purchasing wine or a business buying spare parts for machinery from France will need Euros).

A change in exchange rates might affect a business in the following ways:

Exchange rates changes can increase or lower the price of a product sold abroad

The price of imported raw materials may change

The price of competitors' products may change in the home market

For example an increase in the exchange rate will mean that price abroad goes up, lowering sales; price of imported raw materials falls, either leading to a fall in price and more sales, or an increase in profits; competitors' prices fall, meaning lower sales.

Exchange rate

French car (€15,000)

UK car (£12,000)

French raw materials (€4 per kilo)

Originally £1:€1.5

£10,000 in the UK

€18,000 in France

£2.67 to UK businesses

£ appreciates £1:€1.8

£8,333

€21,600

£2.22

£ depreciates £1:€1.2

£12,500

€14,400

£3.33

The global market for foreign exchange currencies is massive! - Hundreds of billions of ?s and $s are traded in the dealing rooms each day. The market is open 24 hours a day for people, companies and governments needing foreign exchange to finance their transactions. Money now moves round the international financial system at tremendous speed (aided by the spread of computer technology and the gradual abolition of exchange controls between countries). Speculative activity in the market is a major determinant of a currency's value. 

Short and long-term movements in the exchange rate, like any price, are caused by changes in market demand and supply conditions

Demand for Sterling

The demand for sterling (pounds) in the FOREX markets comes from four main sources:

UK goods and services are exported overseas - creating an inflow of currency into to the UK which needs to be turned into sterling

foreign investment flows into the UK economy

market speculators decide they want to purchase pounds in the expectation of making a profit

official buying of the currency by the central bank

An outward shift in the demand for sterling will cause an appreciation in the currency

Supply of Sterling

Sterling is sold on foreign exchange markets when

goods and services are imported (domestic consumers and firms sell sterling to finance their purchase of imports or when they go ...