9 Interaction of exchange rates. Assume that there are substantial capital flows between the United Kingdom, the United States, and the euro area. If interest rates in the United Kingdom decline to a level below the US interest rate, and inflationary expectations remain unchanged, how could this affect the value of the euro against the US dollar? How might this decline in the United Kingdom’s interest rate possibly affect the value of the British pound against the euro?

10 Trade deficit effects on exchange rates. Every month, the UK trade deficit figures are announced.

Foreign exchange traders often react to this announcement and even attempt to forecast the figures before they are announced.

a Why do you think the trade deficit announcement sometimes has such an impact on foreign exchange trading?

b In some periods, foreign exchange traders do not respond to a trade deficit announcement, even when the announced deficit is very large. Offer an explanation for such a lack of response.