By Mark S Astley and Anthony Garratt of the Bank’s Monetary Assessment and Strategy Division.
This article considers the analysis and interpretation of exchange rate fluctuations. It stresses the importance of identifying the sources of exchange rate movements, and recognising the many channels through which they can affect consumer prices. It reports empirical results which confirm that there is no simple relationship between the exchange rate and inflation. Sterling exchange rate depreciations are not necessarily associated with rises in UK consumer prices relative to prices overseas. In particular, UK prices may fall relative to those overseas if the depreciation is caused by increases in aggregate supply or falls in real spending, but rise if it is caused by increases in the money supply.
Interpreting sterling exchange rate movements