A nation’s currency value can have a strong effect on the commodity and the stock markets, hence greatly affecting individuals’ lives. The value of a country’s currency is a fundamental component of the people’s wealth and their ability to purchase goods and services, especially in this contemporary society where globalization has become a key factor. Due to the constant changes witnessed in the valuation of currencies, individuals are required to pay attention to their respective currency market trends to enable them to benefit by using the signals provided by these trends in planning their investment activities.
For businesses, currency valuation is even more critical as it dictates the profits to be generated from exports and imports. A strong currency will often make export expensive while imports cheap, hence leading to increased profit earnings for every good exported to other foreign countries. The value and stability of a local currency against other foreign currency is, however, influenced by numerous factors such as the GDP growth rate, inflation rate, export and import values, and interest rates, and political stability of a nation. This paper, therefore,examines the future values of the US dollar currency and the UK sterling pound currency in the next two years based on the impacts of the factors as mentioned above. The paper also seeks to determine how the performance of these two currencies in the next two years will have a corresponding effect on the UAE Dirham and what will be the inferences of such impacts.
Factors Affecting Currency Valuation
The first important factor that influences the general strength or weakness of a country’s currency is the interest rate. Interest rate refers to the cost of borrowing or saving money from the commercial banks and any other money lending institutions. A higher interest rate is always associated with a higher demand for the currency and vice versa. Investors are often after buying currencies with a higher interest rate because it creates an additional rate of return on the currency exchange which is profitable to the investor. The second factor is inflation which refers to the general rise in prices of goods and services. A higher interest rate prompts for the intervention of a country’s monetary authority to implement various measures which can help cool off the rising prices and give the consumer the opportunity to enjoy a higher purchasing parity. For investors, however, an increase in the inflation rate is always deemed profitable since it translates to a rise in the currency value. A country’s current accounts is another economic factor that influences the value of the local currency. It reflects the earnings from foreign investments and net export. It consists of the total transactional values of exports, imports, and the country’s debt.
An increase in import value compared to the export value results in a deficit balance of trade which often translates to a country spending most of its currency to pay for imported products thus causing depreciation of the local currency. On the other hand, an increase in export value coupled with a decrease in import and debt level always result in strengthening and appreciation of the local currency. A country’s political climate and economic performance have a profound effect on the stability of its currency. For instance, a state with less risk to political turmoil is often more attractive to foreign investors. With the flow of foreign direct investment, there is always an increase in foreign capital which in turn leads to an appreciation in the value of the local currency. Also, a nation with strong and sound financial or trade policies is associated with less room for uncertainty in the value of its local currency. However, a country which is prone to political confusions and weak financial policies is always vulnerable to depreciation in its currency.
Prospects of the US Dollar Currency in the Next Two Years
The US economic outlook seems healthy based on the key economic indicators mentioned above with the most critical being the GDP growth rate, interest rate, current account deficit, and the inflation rate. The US GDP is expected to grow at the rate of3 percent in 2019 before reducing to 2 percent in 2020, and further decreasing to 1.8% in 2021 while the unemployment rate is forecast to maintain its natural rate. On the aspect of inflation, the price of goods and services is expected to remain relatively stable even as the country gears for another presidential election late next year. The inflation rate is forecast at 1.9 percent in 2019 before it rises to 2.1 percent in 2020 and 2021.
According to (Skinner, 2019), the US dollar is expected to decline at a slower pace in 2019 as the Federal Reserve aims at stabilizing the economy. With the continued speculations in the market, it is highly possible that the Federal Reserve might again raise the interest before the end of 2019 based on the occurrences in the previous year. In December 2018, the US Federal Reserve announced the increase in the country’s interest rate from 2.25 percent to 2.5 percent which resulted in the appreciation of the currency (Amadeo, 2019). Based on this, it is likely that the Federal Reserve will again increase these rates to at least 2.75 percent later this year thus resulting in even more stable dollar currency for the first quarter of 2020. However, with the looming presidential election of 2020 and the possibility of the Federal Reserve cutting down the interest rates later that year, the dollar currency is likely to depreciate in the last quarter of 2020 and the first quarter of 2021.
Prospects of the UK Sterling Pound in the Next Two Years
The UK economic growth started on a weak footing in 2018 after an economic slowdown in the previous year, in 2017. However, growth is expected to gain a positive trajectory in the first and second quarter of 2019 but is likely to remain lacklustre throughout the year. The UK’s low unemployment rate remains one of the major economic success stories for the nation over the past year (Gavin, Strauss, Bernard, & Pearson, 2019). With an average unemployment rate pegged at 4 percent this year, the UK economy is seen to be relatively stable. However, the real wages seem to be on the downfall trend after recovering from a financial crisis, with the sterling pond perceived to be also depreciating. The country’s inflation rate is exceptionally low and is expected to remain below the 2 percent mark for the entire 2019 even as the prices of oil continue to fall. However, the most significant concern among investor is the political climate in the country concerning the “Brexit” politics.
According to (Monfort, 2018), a no-deal Brexit could have profound implications on the value of the sterling pounds as it is expected that it may trigger up to 10 percent depreciation in the value of the sterling pound. According to Monfort, the call by British government and parliament to consider conducting another referendum on the issue of Brexit in January 2019 came amidst a broad-based sell-off in Sterling which saw the currency break through the critical technical floor against the dollar to hit the lowest level at 1.2871 making it a notable underperforming currency in the Eurozone. According to OECD, the UK economic growth is projected to increase slightly in 2019 before slowing down in 2020 with the assumption that there will be a smooth exit of Britain from the European Union. Inflation is, however, expected to converge to 2 percent by the end of 2020. These statistics indicate that the sterling pound is highly unstable and its strength will be determined whether Britain exits the EU or not.
Implications of the US Dollar and the UK Sterling Pound Valuation on the UAE Dirham
The relationship between major world currencies such as the US dollar and the sterling pound has a direct effect on the performance of other currencies such as the UAE Dirham. However, this relationship is greatly influenced by the economic and political issues in the US or the UK rather than the UAE. It, therefore, means that the lives of the people and critical investment decisions in the UAE are pegged around the political and economic circumstances in the US and the UK. Since 2007, the US dollar has always had a strong influence on the UAE Dirham and is valued at an average rate of 3.6725 Dirham for every US Dollar. On the other hand, one Sterling pound was valued at an average rate of 4.8617 Dirham in 2018.
It, therefore, means that the appreciation of the US Dollar in 2019 will lead to the depreciation of the Dirham against the dollar while the devaluation of the dollar in 2020 and 2021 will make the Dirham stronger. For the sterling pound, depreciation of the pound in the next two years as a result of the Brexit politics will ultimately result in appreciation of the Dirham against it. The appreciation of the USD and the sterling pound against the Dirham will result in a decline in the prices of oil products which are the main exports of the UAE to these countries. It will also increase prices of goods imported by UAE from the US and the UK which will lead to imported inflation. On the other hand, with the depreciation of the dollar and the pound in 2020 and 2021, the Dirham will appreciate, thus resulting in higher export value, cheap imports, increased positive balance of trade, and an increase in foreign investment in the UAE. It also means that while appreciation of the Dirham against the dollar and sterling pound will ease the cost of living by reducing the price of essential commodities, the depreciation of the Dirham against these two currencies will, however, make life hard by increasing the cost of living in UAE.
Future Expectations of the UAE Dirham
The UAE’s economy is the second largest economy in the Middle East with a gross domestic product of 432 billion USD by 2018 (The World Bank, 2018).Although its economy is highly dependent on oil revenues which is the country’s chief export, the government of UAE is putting more effort to diversify the economy to see other sectors such as tourism and manufacturing generate significant revenues. Despite its economy remaining relatively sensitive to any price shock in the global oil price, prospects appear promising for the UAE economy this year. The country’s economy is expected to witness a significant growth rate due to the strong dose of fiscal stimulus by the government and increased infrastructural investments by the private sector. The relaxation of visa rules, the landmark investment law, and other business-friendly reforms being enacted by the government which are transforming the country into an economic powerhouse in the Middle East. Based on its strong monetary policies, stable political climate, increased GDP growth rate of 3 percent in 2020, increased foreign direct investment, and reduced interest rate, the country’s local currency is expected to appreciate as it gains strength against major world currency such as the US dollar, sterling pound, and the Chinese Yuan. Even with these prospects, it is also possible to experience the challenges such as higher fuel prices, impacts of the VAT introduction, decline in domestic spending and tightening monetary policies as was the case in 2018 as discussed by (Diaa, 2018). In case of a repeat of these issues, then there is a greater chance that the UAE Dirham will depreciate and hence become weak against the major foreign currencies.
The above analysis indicates that apart from a country’s macroeconomic indicators such as interest rate, inflation rate, GDP growth rate, and balance of payment, the value of the local currency is also affected by the economic outlook of other major economic powerhouses like the US and the UK. The above analysis indicates that depreciation of the US dollar and the UK sterling pound against the Dirham is beneficial for the growth of UAE. In conclusion, therefore, it is evident that the monetary authorities in UAE must strive to diversify their economy instead of relying on oil revenues, and ensure that the Dirham currency remains stable against other foreign currencies to enable the people of UAE to enjoy higher standards of living.
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Gavin J., Strauss D., Bernard S., & Pearson T. (2019). The UK economy at a glance. Financial Times. Retrieved on 27th February 2019 from ig.ft.com/sites/numbers/economies/uk/
Monfort J. (2018). Pound Sterling Forecasts: Analysis on the Outlook vs. the US Dollar and Euro. Pound Sterling Live. Retrieved on 27th February, 2019 from//www.poundsterlinglive.com/gbp-live-today/9656-gbp-to-usd-and-eur-exchange-rate
Skinner J. (2019). MUFG Exchange Rate Forecasts: GBP, EUR, and AUD to Rise as USD Falls. Pound Sterling Live. Retrieved on 27th February, 2019 fromwww.poundsterlinglive.com/exchange-rate-forecasts/10637-mufg-exchange-rate-forecast-update-gbp-eur-and-aud-to-rise-as-usd-falls.
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