Expected Future Exchange Rate Analysis Using IRP

Consider the following scenario: A financial analyst is evaluating two countries, the United States and the Eurozone, to determine the influence of parity conditions on their currency exchange rates. The current exchange rate is 1 USD = 0.85 EUR. The interest rate in the United States is 2%, while the interest rate in the Eurozone is 0.5%. The analyst is interested in understanding how the interest rate differential affects the expected future exchange rate based on the Interest Rate Parity (IRP) theory.

According to IRP, the expected change in the exchange rate should reflect the interest rate differential between two countries. Which of the following statements correctly reflects the expected future exchange rate between the US dollar and the Euro given the information provided?