What Factors Impact the Australian Dollar Value?

What Factors Impact the Australian Dollar Value?

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The Australian dollar (AUD) is more than just a fiat currency used by those in Australia for transactions; the currency is a key player in the foreign exchange market. At its core, forex trading refers to the practice of buying and selling currencies in the form of currency pairs. Popular currency pairs include the AUD/USD, EUR/USD and USD/JPY.

Understanding the drivers behind price changes for the AUD is important, particularly for those trading currencies, running businesses or planning a trip to Australia.

Understanding the Australian Dollar

The AUD is the official currency and legal tender of Australia, including its external territories and three independent Pacific Island states: Kiribati, Nauru, and Tuvalu.  

It was first issued on 14 February 1966. The symbol for the AUD is ‘$’, though other symbols, such as A$ or AU$, are also commonly used. The AUD was introduced in order to replace the non-decimal pound, which had been used by Australians, with an exchange rate of two dollars for every pound.

Central banks are important institutions, in place to conduct monetary policy by altering the supply of money for an economy. For the AUD, the central bank is the Reserve Bank of Australia (RBA) and is one of the main drivers behind longer-term trends for the Aussie dollar. 

What Affects the Value of the Australian Dollar?

Ranging from interest rate differentials and capital flows to the dynamics of international trade and market intervention, many factors impact the value of the AUD, each playing a pivotal role in determining the currency's strength/weakness.

1. Interest Rate Differentials

Differences between the interest rates of Australia and any other major economies, such as the United States, Europe or Japan, can influence the AUD.

In turn, higher interest rates in Australia compared to other nations can make the domestic currency more attractive for foreign investors due to the appreciation in yield. On the other hand, lower Australian rates relative to other countries make it less attractive, which can trigger a loss of value for the AUD.

2. Trading Conditions and Prices of Commodities

The terms of trade measure the ratio between export prices and import prices, and it is closely related to commodity prices and the value of the AUD.

Generally, an increase in trade (exports > imports) is linked to appreciation of the AUD, while a decline can reflect depreciation.

Commodity prices may also influence the terms of trade. A surge in commodity prices, such as iron ore, natural gas and agricultural products that make up most of Australia’s export items, may underpin the AUD. This is why you’ll often hear traders and investors refer to the AUD as a commodity currency. 

3. Global Trade Dynamics

International trade involves the buying and selling of AUD to facilitate the exchange of goods and services with other countries. As noted above, increased demand for Australian exports can bolster the AUD; however, imports tend to weaken the currency.

Here’s an example of how it works:

Consider a scenario where an Australian company exports 1,000 items to a client in China. Each item is priced at A$50, making the total export value A$50,000. Assume the exchange rate is 1 AUD = 4.76 CNY for this example.

The buyer needs to acquire A$50,000, which equates to CNY 238,000.

  • If the client decides to buy only 800 items: The demand for AUD drops to A$40,000, and the Chinese buyer now exchanges CNY 190,400.
  • If the price per item rises to A$60: The demand for AUD increases to A$60,000, leading the Chinese buyer to exchange CNY 285,600.
  • If the exchange rate changes to 1 AUD = 5 CNY: The demand for AUD stays at A$50,000, but now the Chinese buyer needs to provide CNY 250,000.

4. Inflation Rates and Price Levels

The main measure of inflation for Australia is the Consumer Price Index (CPI). Many countries, including Australia, focus on both nominal and core inflation, usually on a year-on-year basis released each month. 

If Australia experiences an increase in consumer inflation, this could prompt the RBA to increase the overnight cash rate to control inflation. And with expectations of rate hikes, this can impact the AUD and prompt longer-term trends. On the other hand, should the central bank be expected to cut interest rates in the near future, this expectation could lead to AUD weakness. 

5. Sentiment and Speculation

The AUD is closely tied to changes in risk sentiment among investors. When investors are more willing to take on risk, often due to a positive outlook on economic growth, there's often increased demand for AUD. This is because Australia is seen as a commodity-rich, stable economy, making its currency more attractive in times of positive risk sentiment, given the expectation of demand for raw commodities in economic expansion. Conversely, when risk aversion increases, the AUD tends to depreciate.

The AUD is also subject to short-term fluctuations, often driven by speculation. Traders and investors usually trade on predictions of future exchange rate movements. This speculation can be influenced by a variety of factors, including economic data releases, policy announcements, or global economic events. 

6. Forex Market Intervention

The RBA intervenes in the foreign exchange market by buying or selling AUD in relation to another currency, mainly against the US dollar.

These interventions are meant to generate demand or supply for the AUD with the aim of influencing its value. The RBA has the capability of acting to operate in global markets in all time zones across the globe and mostly on the spot market.

The main objective of these interventions has been to tackle market failures, in particular during periods of major turbulence or unbalanced conditions in supply and demand. For example, during the financial crisis beginning in 2007, the RBA intervened to improve market liquidity and limit disruptive price adjustments. 

It is difficult to measure the extent of effectiveness in which these interventions have yielded but the analysis revealed by the RBA indicates that they have managed to stabilise market conditions.

What Is the Nature of Australia’s Economic System?

Australia is a developed (highly diversified) mixed economy characterised by a blend of both private sector freedom and government involvement. Key sectors to monitor are financial and insurance services, construction, healthcare and social assistance, mining, scientific services, technical services and manufacturing.

Looking into 2024, the Australian economy is demonstrating resilience and is in a relatively good condition. The Australian Bureau of Statistics reported a 0.2% increase in Gross Domestic Product (GDP) in the September quarter of 2023. This growth was primarily fueled by heightened government consumption and capital investment during the quarter.

Final Thoughts

As demonstrated, the AUD is influenced by a number of factors. It is crucial for market participants dealing with the AUD to understand these drivers. They provide insights not only into the future trends of the currency but also offer a wider view in which to assess Australia’s health and direction of its economy.

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Source - database | Page ID - 37743

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