1. Commodity Prices
2. Foreign currencies (in particular China and the US)
3. Interest rates
That’s what they say on the news anyway, but HOW do these things affect the dollar and what actually causes it to move?
What causes it to move?
The Australian dollar was floated on the foreign exchange market in 1983 in one of the biggest monetary policy moves in our country’s history. Like shares in a company when they are floated on the stock market, currencies on the foreign exchange market (FOREX) are subject to market forces such as consumer confidence, market performance and competitiveness.
Over the past 12 months commodity prices have fallen significantly. Commodities are raw materials such as iron ore (Australia’s largest export), coal and copper. Due to Australia’s heavy reliance on the mining sector, commodity prices can heavily affect the dollar.
Secondly, the Australian dollar has dropped on the back of strong gains in the US dollar (the greenback). As the US economy continues to recover due to strong jobs outlook and the US Federal Reserve winding down its stimulus program. This signals that the economic recovery has taken effect which is in turn increasing financial market confidence.
Finally, interest rates. At the time of writing interest rates are low – 2.5%. This is also known as the official cash rate (OCR) which is what the Reserve Bank of Australia (RBA) charges commercial banks for overnight loans. This determines what commercial banks can charge customers (i.e. you and I) to stay competitive and profitable. Because the cash rate is so low – retail loans are also low – Money is cheap!
This affects the Australian dollar due to supply and demand. Because the interest rate is low – demand is high. This increased demand for money drives the value of the dollar up.
It’s not all doom and gloom though. A lower Aussie dollar can be a good thing for Australian Companies.
How can a LOW Australian Dollar be a GOOD thing?
Whether the Aussie dollar is low or high in comparison to the US dollar it will always be good for some and not so good for others. When the Australian dollar is HIGH, our exports become more expensive for foreign countries and our imports become cheaper to buy. When the Australian dollar is LOW, our exports become cheaper for foreign countries to buy but our imports become more expensive.
An easy way to illustrate this is by using online shopping as an example.
If the Australian dollar is buying $0.50 USD then our dollar is LOW, and a $100 USD pair of shoes would cost $200 AUD.
However, if you were an Australian online retailer hoping to sell a pair of shoes to America for $100 AUD it would only cost the American consumer $50 USD.
Therefore Americans would be MORE likely to purchase goods from Australia as they’re effectively discounted.
This is a very simplified example as exchange rates also depend on each countries inflation rate, trade deficits, public debt, political stability and many other contributing factors. But with all other things being equal this is how currency fluctuations can effect global economies.
How Low Can it Go?
Anyone looking to go to the USA for a shopping spree may find this disappointing, however, most economists are tipping the dollar to continue its decline for at least the rest of 2014. Most credible estimates have the Australian dollar somewhere between 0.85 and 0.87 against the US Dollar at 31 December 2014.
Although interest rates are tipped to stay low in the short term, if the inflation rate begins to increase or if the US dollar continues to strengthen, or any number of economic variables change then interest rates will be on the move.
Interestingly, the US stock market appears to be defying the odds and avoiding their long awaited correction, the US has not had a correction (defined as a 10% slide in stocks) for over three years. On the back of this the Australian dollar has strengthened as interest rates appear to be kept low. However, our own (domestic) unemployment report from the Australian Bureau of Statistics is due this month. If this shows that our economy is stronger than we thought the dollar may strengthen.
For this reason it is important to understand your cashflow and your repayment capacity. It’s also an excellent time to review your investment options. Book in today to speak to one of our consultants to discuss your current or potential loans and what investment opportunities exist for you in this particular economic climate.