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The exchange rate of the Australian dollar against the US dollar
- Charlotte Pa’asia
Since the 2008-9 global financial crises, Australian has been progressively recovering from the recession; there’s been slightly increase and decrease since then, however according to the figures by the (Reserve Bank of Australia’s (RBA), 2014), the exchange rate of the Australian dollar against the US dollar, although has been fairly steady over the last 36 months though there have been rise and fall in the exchange rate. Some of the causes of these activities will be discussed.
An exchange rate plays an important role in a country’s level of trade, which is critical to most every free market economy in the world. Nevertheless exchange rates matter on a smaller scale as well: they impact the real return of an investor’s portfolio. Therefore we look as some of the major forces behind exchange rate movements.
There are many factors that influence the value of the Australian dollar compare to other currencies. These include:
- Differentials in Interest rate – This is the difference between real interest rates between countries; higher interest rates attract foreign capital and cause the exchange rate to rise.
- Relative inflation rates between nations – Higher relative inflation will reduce demand for exports and increase demand for imports, thus lowering the value of the currency.
- Commodity Prices /Terms of Trade – If the price of a country’s exports rises by a greater rate than that of its imports, its terms of trade have favourably improved.
- Growth in Real GDP – Domestic growth affects the demand for imports but growth rates in the international economy will influence the level of a nation’s exports.
This essay will focus on the movement in the exchange rate over the last 36 months. As indicated by RBA, Australia’s exchange rate has been slowly decreasing since 2011with slight peaks in between. According to Figure 1, from August 2011 to early 2012 there have been slight hike and drop in the trend, however from mid-2012 to beginning of 2013 there was a steady movement, then around April 2013 to June 2013 there was a sharp decline in the exchange rate, there was a slight increase in October still the exchange rate decline in end of 2013 to beginning of 2014 and has been slowly rising.
These declines in the exchange rate are triggered by various factors of which will be discussed.
Thus, the movement identified in the figure will be discuss
The paper will focus mainly on identifying the movement in the exchange rate graph (above) and explaining the cause of the movement.
- Decline from August to October 2011
- Decline from April to June 2012
- Steep decline from the year February to August 2013
- Slight increase from the year August to October 2013
- Slight decrease from October to December 2013
- Steady movement since beginning of 2014 to current month.
Interest rate differential
One of the factors that contributed to decline is Australia’s interest-rate differentials with the US. Interest rate impact inflation and currency values, for instance if Australia’s interest rate rise relative to US, it will become more beneficial to invest in the Australian economy and vice-versa if the interest rate fall. The Australian interest was relatively higher in the past years which is the reason foreign investors have moved money into the Australian dollar because they can get a higher interest rate on lending than they can in the US. So if the interest rate differential goes down because money becomes a bit more expensive in the US, people who are lending money in the US will get higher rates of return, and money will flow out of the Australian dollar, lowering the exchange rate.
According to Rate Detective (2014), RBA has been consistent with the interest rate of 4.75% since November 2010 to 2011, nonetheless in November of 2011 the RBA cut its official interest rate by 0.25% to 4.50% for the first time in two and a half years. The RBA made its second interest rate cut in a row in December to 4.25% though the interest rate was unchanged at 4.25% from December 2011 to April 2012. The steep decline in the exchange rate movement from February to August 2013 was possible triggered by the 0.25% cut from 3.25% in November 2012 to 3% in December 2012 which was at par with the lowest rate in April 2009 during the height of the global financial crisis. The 3% rate was steady up till May 2013 when RBA cut interest rate from 3% to 2.75% this puts the current rate to the lowest it has been so far since RBA began setting monetary policy.
The cut in the interest rate is caused by the continuing weak performance of Australia’s mining, manufacturing, and services industries (Rate Detective, 2011).
Garrett (2013) states “if and when US monetary policy returns to more normal, the interest rate differential between Australia and the US will go down. The less encouragement people have to put their money in Australian dollars, the lower the “Aussie” dollar will go.”
Mr. Garrett also stress that the Australian economy is slowing down which is why the RBA has drop interest rates. The drop on interest rate will also reduce the difference between US and Australian interest rates, once more putting downward pressure on the Australian dollar (Garrett, 2013).
Commodity Prices & Terms of Trade
One of the foremost influences on the Australian dollar has been the terms of trade. For instance, increase in the term of trade as a result of a rise in the prices of commodities provides an expansionary urge to the economy through an increase in income.
Over the past decade China has contributed greatly to the sharp rise in Australia’s terms of trade. China’s economy is vital to Australia as it rely on the Chinese economy for exports and import. Hence if there is a decline in the Chinese economy it also affects Australia as it rely heavily on China demand for exports of iron ore, and coal, Therefore since the new shift happening in China and the rest of Asia which is these economies are no longer growing at the Frantic pace that Australia have become used to over the years, the Australian dollar has dropped as a result of this. For instance, exchange rate peak in the second half of 2011 as a result of the peaked in the term of trade in Australian and it was prediction to continue to weaken slowly over the next few years as the global supply of bulk commodities surges (st.george, 2013). The sharp decline 2013 was triggered by the weakening commodities industry and prices fall. After holding up during the second half of 2013, iron ore and coal prices have fallen sharply since the beginning of 2014. The decline has been due to weaker demand for steel, a period of negative sentiment around China’s economic growth prospects, as well as rising global supply, in particular due to recently built capacity coming on line from Australia. (Atkin & Connolly, 2013)
Iron ore prices are expected to fall further in 2014‑15 and 2015‑16, reflecting further growth in global supply and slower growth in demand for steel. Metallurgical coal prices are expected to rise slightly over the forecast period as global supply growth slows, while thermal coal prices are forecast to remain stable (Charts 6 and 7). (Atkin & Connolly, 2013)
As discussed, the movement in the exchange rate of the Australian and US dollar over the last 36 months was caused by various factors of which two were discussed. However other factors not discussed are Relative inflation rate, Growth in real GDP and much more. Interest rate and terms of trade were two of the key factors in driving the movement in the exchange rate which is the reason they were discussed. However of the two discuss, commodity and term of trade is probably the foremost factor in driving the exchange rate in Australia since Australia predicted the mining sector to be the driving force of Australian dollar and has strengthen the Australian dollar in 2011 at the peak of the mining boom. Although the mining industry has not performed as expected due to the Asian economy slowing down as has toughen the Australian economy into making necessary cuts in the interest rate.
- Atkin, T., & Connolly, E. (2013). Australian Exports: Global Demand and the High Exchange Rate. Retrieved from http://www.rba.gov.au/publications/bulletin/2013/jun/1.html
- Blundell-Wignall, A., Fahrer, J., & Heath, A. (1993). Major influences on the Australian dollar exchange rate. The Exchange Rate, International Trade and the Balance of Payments, Reserve Bank of Australia, Sydney, 30-78.
- Garrett, G. (2013). Reasons why we should expect a lower Australian dollar. Retrieved from http://theconversation.com/reasons-why-we-should-expect-a-lower-australian-dollar-15386
- Kent, Christopher. (2014). The Resources Boom and the Australian Dollar: http://www.rba.gov.au/speeches/2014/sp-ag-140214.html
- Kohler, M., Manalo, J., & Perera, D. (2014). Exchange Rate Movements and Economic Activity. RBA Bulletin, 47-54.
- Manalo, J., Perera, D., & Rees, D. (2014). Exchange Rate Movements and the Australian Economy (No. rdp2014-11). Reserve Bank of Australia.
- Rate Detective. (2014). Interest rate Updates. Retrieved from http://www.ratedetective.com.au/interest-rates/
- Reserve Bank of Australia. (2014). Statement on Monetary Policy. Retrieve From http://www.rba.gov.au/publications/smp/2014/feb/pdf/0214.pdf
- Reserve Bank of Australia. (2011). The Mining Industry: From Bust to Boom. (Research Discussion Paper). Retrieved from http://www.rba.gov.au/publications/rdp/2011/pdf/rdp2011-08.pdf
- St.george. (2013). Australian Dollar Outlook. Retrieved from http://www.stgeorge.com.au/corporate-business/report-centre/australian-dollar-outlook
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