An exchange rate is the current market price for which one currency can be exchanged for another (OSullivan, Arthur; Steven M. Sheffrin (2003). For example, if the U.S. dollar buys 1.40 Canadian dollars, the exchange rate is 1.4 to 1, which means that 1 dollar can be exchanged for 1.4Canadian dollars. The rate of exchange of the currencies between two countries measures the competitiveness of the country's economy. Hence, it is analyzed and forecasted as one of the important indicators of the nation's progress. The exchange rate is determined by the level of supply and demand on the international markets. In this topic, the writer analyzes the extent to which the macroeconomic factors (like GDP, Inflation, Interest Rates and Balance of Payments) impact on the exchange rate of US dollar to Swiss Franc, the US dollar to UK pound sterling and US dollar to Euro over the last thirty years, thru the help of regression analysis.
US dollar to Swiss Franc
The U.S. dollar and Swiss Franc (USD/CHF) currency pair specifies how many Swiss Francs are needed to purchase 1 U.S. Dollar. In other words, the value of this currency pair is quoted as 1 U.S. Dollar per x Swiss Francs. The Swiss franc has been appreciating in real terms, over the past three decades, against the euro and trading partner currencies in general (i.e. the effective exchange rate), but not against the US dollar (Samuel Reynard, 2008). Other factors, like oil prices, current account positions, and (not always significant) interest rate differentials also affect the Swiss franc evolution; the rise in oil prices could partially explain the recent weakness of the Swiss franc. There have frequently been substantial and persistent exchange rate movements not explained by fundamentals, especially with respect to the US dollar. The short- and medium-term behavior of the Swiss franc has recently been affected by the introduction of the euro, which has had a stabilizing effect on Swiss franc fluctuations as the CHF/euro and CHF/dollar exchange rates have moved in opposite directions; the recent weakness of the Swiss franc with respect to the euro could thus have been partly caused by a weak dollar (supra). Moroever, The inflation rate in Switzerland was recorded at -0.40 percent in November of 2012. Inflation Rate in Switzerland is reported by the Federal Statistics Office of Switzerland. Historically, from 1956 until 2012, Switzerland Inflation Rate averaged 2.66 Percent reaching an all-time high of 11.92 Percent in December of 1973 and a record low of -1.37 Percent in June of 1959. In Switzerland, the inflation rate measures a broad rise or fall in prices that consumers pay for a standard basket of goods (http://www.tradingeconomics.com/switzerland/inflation-cpi).
The US dollar against the Swiss Franc is mostly considered as the 'safe-haven' currency because part of the core value of swiss franc, CHF is backed up by gold. When gold price appreciates and/or during geopolitical challenges the Swissfranc usually rises as investors look to safer grounds. The majority of time, USD/CHF moves on dollar dynamics and not Swiss dynamics. Therefore since many Commodities are priced in dollars, so when the dollar rises, commodity prices fall (Kathy Lien, 2012).Switzerland's economy benefits from a highly developed service sector led by financial services and an industrial manufacturing industry that specializes in high-technology. Switzerland remains a safe haven for investors, because it has sustained a degree of bank secrecy and has kept up the franc's long-term external value.
US dollar to UK pound sterling
The GBP/USD (British pound sterling to U.S. dollars) cross rate exchange is one of the major currency pairs that make up 85% of all of the currency cross rate trades. To buy the GBP/USD you would be speculating on the British Pound/Sterling strengthening vs. the US Dollar. If you were to sell the GBP/USD you would be speculating on the British Pound/Sterling weakening vs. the US Dollar. There are many factors affecting the GBP/USD cross rate. Money supply, inflation, interest rates, Gross Domestic Product, Balance of Trade numbers, political turmoil and commodity prices if the country relies heavily on a commodity (oil, metals, agriculture) for its GDP (http://www.tkfutures.com/GBP_USD_trading.html).
From 1996 to 2006, the UK economy prospered, with unemployment falling, household spending rising, but with interest rates also rising. At that stage Sterling was 'undervalued', and speculators sought to buy Sterling. High levels of FDI also helped push Sterling to record levels, peaking in 2000. During the period of 2007 up to early 2009, the value of Sterling fell over 20%. This was due to: 1) Restoring UK's lost competitiveness. UK had large current account deficit in 2007; 2)Bank of England cut interest rates to 0.5% in 2008; 3) Recession hit UK economy hard. Markets expected interest rates in UK to stay low for a considerable time and 4) Bank of England pursued quantitative easing (increasing money supply). This raised prospect of future inflation, making UK bonds less attractive. (http://www.economicshelp.org/macroeconomics/exchangerate/factors-influencing.html).
The British pound depreciated against the U.S. dollar between 2005 and 2010. In December 2006, 1 pound cost 1.96 dollars but by March 2010, the pound had depreciated to 1.33 dollars.With the slowdown in the US economy gaining momentum, the British pound, which fluctuates in parity with the Euro, did not rise against the US dollar. The British pound began declining amidst a number of crises, including the weakening stock market around the world and the housing problems in the US. The subprime problems in the US particularly impacted the UK, since the British economy is driven by the financial services sector (http://www.economywatch.com/exchange-rate/uk-pound-sterling.html).
US dollar to Euro
When the euro was launched on January 1, 1999, the U.S. dollar-euro ($:€) exchange rate stood at $1.16:€1. At that price, the euro was overvalued by roughly 10 percent relative to measures of its purchasing power parity (PPP) level (Roman Frydman and Michael D. Goldberg (2007). The real exchange rate of the ("synthetic") euro vis-à-vis the dollar has declined markedly in the period from 1995 to 2002. This decline has often been associated with relative productivity developments of the United States and the euro area over this time span. In particular, average labourproductivity (ALP) accelerated in the United States, while it decelerated in the euro area (supra).
Business journalists, policy makers, and market participants offer explanations of exchange rate movements in Euros and US dollarsin regardto trends in macroeconomic fundamentals. The euro's recent rise against the dollar is a case in point: most accounts pin it on the U.S. economy's growing weakness relative to Europe, a rising interest rate differential (Europe minus U.S.), and a continuing accumulation of dollar-denominated assets by euro-zone countries and others because of enormous U.S. current account deficits (supra).
Euro went on to rise so sharply in the period before the 2008 financial crisis. Economic growth in the euro zone was actually quite sluggish in those years, substantially lower than in the U.S. and many other countries. Between 2002 and 2007, the euro area economy grew at an average annual rate of just 2 percent, compared with 2.6 percent in the U.S. and a buoyant 4.4 percent for the world economy as a whole. Yet in that period, the euro appreciated strongly (Peter Gumbel, 2012). Many national and corporate bonds denominated in euro are significantly more liquid and have lower interest rates than was historically the case when denominated in national currencies. A credible commitment to low levels of inflation and a stable debt reduces the risk that the value of the debt will be eroded by higher levels of inflation or default in the future, allowing debt to be issued at a lower nominal interest rate. The introduction of the euro has led to extensive discussion about its possible effect on inflation. In the short term, there was a widespread impression in the population of the eurozone that the introduction of the euro had led to an increase in prices, but this impression was not confirmed by general indices of inflation and other studies (Paolo Angelini; Francesco Lippi (December 2007).
