Determination of exchange rates in UK
A floating exchange rate is one determined without government intervention. E.g. the UK, at present. The general determinants of exchange rates are:
1. Consumers’ demand / supply for currency: i.e. overseas consumers demand UK £s to pay for UK goods / services. As with general demand and supply laws, an increase in demand for £ —> higher value (price) for the £. This is ‘balanced’ by the increase in supply of £s resulting from UK tourists traveling abroad when they exchange for foreign currencies.
2. Currency trading: i.e. on the international currency markets, where dealers buy / sell currencies thus creating demand / supply for currencies as above.
3. Currency speculation: Here, currency speculators sell vast amounts of weaker currencies —> falling values for such currencies (E.g. UK £ in 1992: ‘Black Wednesday’). When the currency has fallen to a much lower value, it is repurchased at this cheaper rate by the speculator, thus providing them with huge profits.
4. National price levels (Inflation rates): If UK inflation is higher than that in the USA, for example, this suggests that UK goods / services will be more expensive to US consumers. This —> fall in demand for such goods / services —> fall in demand for UK £s —> fall in the value of the UK £ against the US $.
5. Economic / political crises: whereby currency traders will ‘switch out’ of currencies / economies beset by such problems —> falling demand for / values of such currency. E.g. value of US $ following Clinton scandal (1998); value of euro during Kosovo crisis (March-June 1999).
