S. inflation and decrease in British inflation means that there will be a decrease of exports from the U.S. to Britain and an increase of imports from Britain in the United States. This will therefore reduce the supply of British pounds for sales. Thus, the increased U.S. demand for pounds and the reduced supply of pounds for sale will put upward pressure on the value of the pound.
On the other hand, the British pound will also change in that the relative interest rates affect investments in foreign securities, which also influences the demand for and supply of currencies and therefore exchange rates. Since British interest rates are expected to decline and U.S. interest rates are expected to increase, we can expect capital flow to increase from Britain to the U.S., while capital flow from the U.S. to Britain will decrease. Due to an inward shift in the demand of British pounds and an outward shift in the supply of British pounds for sale the equilibrium exchange rate should decrease meaning downward pressure placed on the pounds value.
The answer will also depend on the volume of international trade and capital flows between the two countries. To determine which is more influential, we have to consider the volume of international trade and cash flows. If the two countries engage in a large volume of international trade but a small volume of capital flows, then inflation will be more influential, and the pound will appreciate. However if the two countries engage in a large volume of capital flows but a small volume of international trade, then interest rate fluctuations will become more influential and would result in depreciation of the pound. The inflation rates are placing upward pressure on the value of the British pound, while the interest rates are placing downward pressure on the value of the British pound, but Mesa believes that the value of the pound is very sensitive to changing international capital flows, and is only moderately sensitiv View More »