is it Spot * (1+inflation_price)/(1+inflation_base)
or based on % diff inflation_base - inflation_price?
thanis.
First one is exact number. Second is approxiamation.
Assume 1.5 EUR / USD last year.
If US CPI has increased by 50 percent since last year, and the euro inflation index has increased by 20 percent, the resulting inflation differential is 20 percent. According to PPP, to offset higher inflation in the U.S., the euro must appreciate by the same percentage:
(1-30%) x 1.5 = 1.05 EUR / USD. This is where the euro should appreciate to.
Remember a lower exchange rate means higher value of the price currency. No matter what I do it’s always been counterintuitive to me.
ok thank you both!
Mellex, I believe you meant above that “resulting inflation differential is 30 percent”.
30% 