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The Australian dollar has been a free-floating currency since 1983, and in that time, has become one of the most frequently traded currencies in the world. There is a multitude of reasons why – for example, Australia is a gateway to emerging Asian markets, and our timezone means trades are conducted through Sydney while Europe and North America are asleep.
As a frequently traded and accessible currency, the Aussie dollar is easy for forex traders to get into – and back out of – making it attractive and in some ways low-risk option for forex traders.
But if you’re thinking of trading in the Australian dollar, then it’s important to first have an understanding of the underlying economics that affect it. While that includes many different factors one major influence on the AUD is the Reserve Bank of Australia’s monetary policy and how it sets the official cash rate.
The Reserve Bank of Australia’s influence
Like other Central Banks, the RBA uses the cash rate to influence the economy and currency. Although the Reserve Bank of Australia usually takes an overall conservative approach to monetary policy, and would often rather ‘wait and see’ than intervene too much, when the economy needs a boost a lower AUD is desirable in order to support exporters. So the value of the AUD is not just a side effect of cash rate decisions – it's actually one of the factors the RBA considers when deciding whether to cut or increase the cash rate.
Aside from this conscious effort to control the value of our currency from the RBA, the other really important thing to keep an eye on is how the official cash rate in Australia compares to official rates from central banks around the world.
Aussie interest rates and the Fed
Historically, Australia has often had relatively high interest rates compared with other countries in the developed world. At the moment, however, Australian interest rates are at an all time low, and are expected to stay there for the foreseeable future. They’re currently lower than in the US, where the Fed has adopted a policy that’s pushing rates higher.
When this happens, and overseas interest rates are higher than those in Australia, it adds downward pressure to the value of the dollar as investors chase the higher rates available elsewhere. There are numerous other factors that influence the value of the AUD, but generally, the bigger the difference between the Australian cash rate and those in other countries, the more the dollar will drop against those countries’ currencies. That’s an event that all forex traders – particularly those with a vested interest in the AUD – should know about.
Here’s an example. At Mozo, we’ve recently been seeing lenders raise borrowing interest rates out of cycle with the Reserve Bank, as funding cost pressure impacts their bottom line. Combined with this, if the strength of the economy runs below expectations for any significant time, the RBA may consider cutting the official cash rate in order to counterbalance those out of cycle increases. Most economists consider it unlikely at this stage, but there’s an outside chance that when it does come, the next move will be a rate cut.
Looking to the future
If the RBA cuts while the US Fed is still pushing rates upward, the gap between these official cash rates will widen and this has the potential to push the Australian dollar down sharply.
On the other hand, a rate rise as the next move is more likely, and would start to bring Australia’s official cash rate more in line with the US (assuming the Fed left rates alone this time). This may cause the Aussie dollar to spike against the greenback, temporarily at least, which is good news for anyone travelling, shopping online, transferring money overseas – or for forex traders who had their eye on the ball and were ready for the change.