Exchange Rate Indices (ERIs)
Between the Bretton Woods Agreement in 1944 and the currency realignment of the Smithsonian Agreement in 1971, the US dollar provided one benchmark against which changes in the value of other currencies could be measured. This was because up to that time, the value of most currencies remained fairly stable in terms of the dollar, and significant "step" changes to exchange rates were infrequent and confined. Since 1970, however, there have been much larger movements in exchange rates and it can no longer be assumed that changes in rates against the dollar accurately indicate the overall change in the exchange rate for a currency.
To measure the overall change in the exchange value of a currency, a weighted average of the movements in cross-exchange rates against a basket of other currencies can be used, with the weights reflecting the relative importance of the other currencies, as measured by trade flows between the relevant countries.
To reflect changing trade flows, effective exchange rate indices (ERIs) with different currency, weight compositions and methodologies have been introduced. On 1 January 1977, an ERI relating to 1972 trade flows (formerly 1969 trade flows) with a base date of 18 December 1971 (i.e. the date of the Smithsonian Agreement) was inaugurated. This was followed on 2 February 1981 by an index relating to 1977 trade flows in all goods and with a base year of 1975 = 100. This was replaced on 3 January 1989 by an index relating to weights derived from disaggregated trade flows in 143 manufactured products in 1980, and with a base year of 1985 = 100. This was subsequently updated to a base year of 1990 = 100 (see below for further details).
Sterling ERI (1990 = 100)
The trade weights reflect aggregated trade flows in manufactured goods for the period 1989 to 1991 and cover 21 countries. The base date for the index is 1990, and is set at 100. Looking at the two rates which are most requested by users, the main weights in the index are:
UK sterling: Germany (22.49%), United States (16.49%), France (12.59%), Italy (8.27%) and Japan (7.00%). The EU accounts for 69.96% and euro area countries for 64.82%.
US dollar: Japan (30.29%), Canada (25.09%), Germany (11.50%), United Kingdom (8.91%) and France (5.84%). The EU accounts for 41.19% and euro area countries for 29.80%.
The method used to calculate these ERIs (excluding that for the euro - see below) was introduced with effect from 1 February 1995 and the previous index discontinued from 28 February 1995. The base year for these ERIs is 1990 = 100. They are calculated by geometrically weighting together bilateral exchange rates against sterling for all the currencies previously included, with the addition of those of Australia, Greece, New Zealand and Portugal, bringing the total to 21 currencies, 13 of which are EU currencies. Each currency in the index is given a weight which reflects that country's relative importance to UK trade in manufactures based on 1989-1991 average aggregated trade flows. Using the USA as an example relative to the UK, the weights are based on:
- The importance to UK domestic market imports from industrial countries of imports from the USA.
- The degree of competition between the UK and the USA in the USA market.
- The degree of competition in third country markets.
The calculation of these ERIs (excluding the euro) is explained more fully in the February 1995 Quarterly Bulletin, page 24; these indices for all currencies use the IMF method. The ERI measures published are in nominal terms.
The Sterling ERI (1990 = 100) will not be published after 31 May 2006. For sterling effective exchange rate information, please refer to Sterling ERI (2005 = 100).
Euro area ERI
Since 11 May 1999, the Bank of England has published a daily effective trade-weighted exchange rate index for the euro area. It is also compiled on the basis developed and used by the IMF. The weights reflect the pattern of trade between the euro-area as a whole and countries outside the euro area. (Trade between countries within the euro-area is excluded, so the weights are based solely on extra euro-area trade). Sterling has the biggest weight, with the US dollar the next largest.
The index is calculated by weighting together the individual exchange rates for the 12 euro-area currencies against non-euro area currencies. So it represents an effective index for the 12 euro area currencies as a group. This permits the index to be calculated prior to 31 December 1998, using "synthetic" euro exchange rates. These are calculated by geometrically averaging the bilateral exchange rates of the original 11 euro-area currencies using "internal weights" based on the country shares of extra euro-area trade.
The calculation of the euro effective rate index is explained more fully in the May 1999 Quarterly Bulletin, pages 190-194.
Although the indices published by the Bank and the IMF use the same methodology (and weights produced by the IMF), the ERI data may differ because of the actual exchange rates used. The IMF publishes monthly data relating to exchange rates supplied by the relevant central banks. The Bank publishes daily rates using middle market rates for each component currency as observed by the Bank's Foreign Exchange Desk in the London interbank market during the late afternoon.
National Competitiveness Indicators
Until mid-2002, effective exchange rates continued to be calculated for the legacy currencies of the individual EMU countries. These indices are best thought of as indicators of national competitiveness and were calculated using the same method as for other currencies. As such, there are no discontinuities in the series.
The exchange rates for the legacy currencies that were used in the calculation of the national competitive indicators were calculated using the conversion rates irrevocably fixed on 1 January 1999 (2001 for Greek Drachma). For example, the Deutsche Mark's value against the US Dollar is calculated by multiplying the euro rate against the US Dollar by the Deutsche Mark: euro fixed conversion rate.