What affects exchange rates?
the exchange rate can be affected by domestic and foreign price levels, domestic and foreign interest rates and the nominal exchange rate. In effect as the domestic price level increases or the foreign price level falls, the exchange rate falls (experiences a depreciation). With the interest rate, if the uk for instance decides to lower its interest rate then flows of hot money will leave the country and enter other countries that have a higher relative rate. As a result the demand for pounds will fall and the demand for other currencies will increase thereby inducing a fall in the exchange rate (sounds familiar to whats happenin in the real world???
