Discuss and Analysis the Movements in Value of the Euro Against the Pound Since January 2008
The value of Euro varies with time by a floating exchange rate against British Pound (GBP). Hence, the exchange rate influenced the value of Euro against GBP and law of one price is assumed. Theories such as the relative Purchasing Power Parity and the fisher effect illustrate the impact of the inflation and the interest rate between two countries on the value of the currency. The asset market model is also another instrument to analyse the movement of a currency. The constraints of using these models are those theories all assumed perfect efficiency of market and the increasing role of global capital flows is ignored. Therefore they …show more content…
The world economy was dragged by the financial crisis in the USA and Iceland. In contrast to the Euro area, the UK had suffered more.
The Euro was at 0.74, its weakest point at the beginning of 2008. The reduction of interest rate announced by Bank of England and the UK debt level which was greater than 40% of GDP made the value of GBP depreciated significantly and dropped by 27% (Fig 4). The inflation rate of the Euro area and the interest rate of the UK affected the value of Euro. The inflation rate of EU dropped to 1.6% (Fig2), whilst the UK’s rose over 3%. This made the euro exports unattractive. However, because the UK had the similar trend in inflation (Fig3), the overall effect was then offset in the beginning of 2008. This explained the reason why the movement of Euro was fairly constant from April to October. The value of euro has maintained at the range of 0.7901 to 0.8130.
Source : ECB, Annual Report2009 (Fig4)
According to the Interest Rates Review 2008, as the Bank of England tried to counteract the widespread credit crisis on the housing market, the interest rates cut by a quarter of a point to 5% and dropped further towards the end of 2008. The interest rate of EU, 6.5% was relatively higher than 5% which caused