Relative Interest Rate Effects on Exchange Rates

Steps:

• Prolonged USD depreciation weakens it against GBP, setting a baseline.
• US rate hike attracts capital inflows, pressuring USD to appreciate.
• UK rate hike attracts inflows to GBP, pressuring it to appreciate (USD to depreciate).
• Net USD/GBP effect hinges on relative hike magnitudes, which are unspecified.

Why D is correct:

• Uncovered interest parity states exchange rate expectations adjust to interest differentials; without differential size, outcome is indeterminate.

Why the others are wrong:

• A: USD falls only if UK hike exceeds US hike.
• B: Unchanged only if hikes are identical in size and timing.
• C: USD rises only if US hike exceeds UK hike.

Final answer: D