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A-Level Economics · Currency appreciation (hot money) diagram question

EVALUATION: when you analyse an interest-rate rise, why link it to the EXCHANGE RATE before the inflation effect?

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The answer

Financial markets are extremely efficient — the currency moves within minutes of the announcement, while demand-side policy takes about two years to move inflation. Anything running through the financial sector happens fast: whoever hears the news first profits by buying the pound first. Trump announces tariffs and the market is down three minutes later. Speed decides the ordering. A rate rise appreciates the currency almost immediately — the same day, even within minutes — whereas demand-side policy takes roughly two years to filter through to inflation. So over the first couple of years the currency effect dominates export prices, even though lower inflation eventually makes exports a little cheaper too. Saying that explicitly is an evaluation point, not a footnote.

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