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The Interest Rate Transmission Mechanism

The Relationship Between Changes in Interest Rates and Exchange Rates

The animation below allows you to see what happens to exports when the interest rate rises or falls. The initial rate is assumed to be 3% with the exchange rate set at £1 = $1.60 and £1 = €1.50.

Use your mouse cursor (or tab to the animation and use the up and down arrow keys) to raise or lower the interest rate. Look what happens to the exchange rate and then observe the effect on the prices facing buyers in the US and the eurozone. The effect on trade is signified by the amount of goods flowing between the UK and its trading partners. You can stop/reset the animation by using the stop button or pressing q. The main introductory page features further accessibility information on these resources.


No Flash plugin detected: The animation would allow the user to identify what the effect on the exchange rate of the pound against the dollar and the pound against the euro would be if interest rates in the UK changed. The animation would allow the user to identify what the effect on the exchange rate of the pound against the dollar and the pound against the euro would be if interest rates in the UK changed. The interest rate in the UK is assumed to be at 3% and the exchange rate to be at £1 = $1.60 and £1 = €1.50. If the interest rate in the UK is raised by 1% to 4%, the exchange rate will alter - £1 would now be worth $1.70 and €1.60. The price of exports from the UK would rise and the demand for exports fall, illustrated by a slowdown in the movement of goods to the US and Europe. If the interest rate in the UK is lowered by 1% to 3%, the exchange rate will alter - £1 would now be worth $1.50 and €1.40. The price of exports from the UK would fall and the demand for exports would rise illustrated by a speeding up in the movement of goods to the US and Europe.

Previous: The Impact of a Rise in Interest Rates on UK Sterling Exchange Rate | Index: Interest Rate Index | Next: The Balance of Payments: Exports