Exchange Rates Respond to Changes in Relative Interest Rates
If U.S. interest rates rise relative to British interest rates, British citizens holding pounds may be attracted into the U.S. securities market. To buy bonds in the United States, British buyers must exchange pounds for dollars. The supply of pounds shifts to the right, from S0 to S1.
However, U.S. citizens are less likely to be interested in British securities because interest rates are higher at home. The demand for pounds shifts to the left, from D0 to D1.
The result is a depreciated pound and a stronger dollar.