Valuation of currencies
How to determine whether a currency is over- or undervalued?
To say whether a currency is under- or overvalued is not an easy task. However, there are some ways to roughly calculate if the exchange rate is close to it’s equilibrium or not.
Short term impact on exchange rates
If we ignore the technical analysis, currency rates can in the short-term have impact of central bank interventions. There are also other financial capital movements that may result from the investment climate in the country. In such cases, it is important to stay well informed about what happens in the currency market in order to determine whether a currency is over -or undervalued.
Then you can look at purchasing power parity, PPP, and how such sterling relate to the New Sterling Exchange Rate Index (ERI).
Read more about the ERI Index below.
What is ERI Index?
The ERI–index, New Sterling Exchange Rate Index, is a way of measuring Sterling’s value against a basket of other currencies. Of the 15 currencies included in ERI Index, the Euro, U.S. dollar and Japanese yen are the most important. Read more about ERI
Sharp changes in ERI Index?
If we see a sharp change in a very short time, you could say that there is an anomaly. This may involve the central bank to intervene in order to strengthen or weaken the Sterling. Other causes may be political or economic unrest in the world. At such times, the exchange rate tends to return to the average level when uncertainty has subsided. The exchange rates usually tend to corrected themselves within 0 to 2 years.
Purchasing Power Parity (PPP)
Purchasing Power Parity, PPP, can be used to obtain a picture of a currency is over-or undervalued. Learn more about purchasing power parity.
German economical development indicator – ZEW
One way to assess the economical future for Germany, and thereby the euro currency is the ZEW indicator. This is an indicator where a group of a few hundred analysts are surveyed about their view on the economical future in Germany, UK and a few other countries.