What do you predict will happen to the foreign exchange rate if interest rates in the United States increase more than in the UK? In other words, which currency will become stronger? How would such a change affect US exports to the UK? Would it be less expensive for an American tourist to take a vacation to London after the interest rate change?

A rise in interest rates will increase the value of the currency. If the dollar rises against the pound, this puts pressure on US exports to the UK, as they become more expensive for the importer, but makes it cheaper for an American to take a holiday in London.

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If interest rates rise in the United States, this will generally cause exchange rates to rise. The strength of the dollar is not straightforwardly linked to the health of the US economy because the dollar is used as a reserve currency by many people all over the world, but there is still a close relationship between the two. As interest rates rise, the country becomes more attractive to investors, causing the currency to become more valuable. This, however, will also put pressure on US exports. Assume the value of the dollar rises, so that £1, which was worth $1.35 last week, is worth $1.25 this week. A shipment of goods from the US to the UK priced at $10,000 cost the British importer £7,400 last week. Now, the same shipment of goods brings the exporter the same $10,000 but costs the British importer £8,000. This means the importer is likely to look for more cost-effective alternatives.

The same change which makes American imports more expensive for the British also makes your dollar worth more in London, making your holiday cheaper. To continue with the same level of increase, when you change your dollars into pounds, you receive £80 for every $100, when you would only have received £74 for the same amount in the previous week.

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