Inflation Rate & Exchange Rate
Inflation rate and exchange rate has relation. Domestic inflation rate is higher than other
currency it means that domestic currency is falling in relation to foreign
currency. Similarly if the inflation rate in foreign currency is higher as
compared to domestic inflation rate, it means domestic currency is
strengthening.
Example Inflation Rate
& Exchange Rate
|
Spot Rate $/pound
|
1.5230
|
|
USA inflation Rate
|
5%
|
|
UK Inflation Rate
|
9%
|
|
|
|
Calculate the future Exchange rate
Solution
1.
First Currency & 2nd
Currency
First currency is USD and 2nd Currency is pound.
Formula for future
Exchange Rate = Spot Rate x (1+ Inflation Rate first Currency)
(1+ inflation 2nd Currency)
= 1.5230 x (1.05)/ (1.09)
= 1.5230 x (.9633)
=1.4671
It
is evident from the above example that inflation rate in foreign currency is
high i.e. foreign currency devolution rate is high and therefore USD has
strengthened against foreign currency.
