Overview of Australian Dollars (AUD)
Australia is the fifth largest country in the Asia-Pacific region by GDP. Although the economy is relatively small, it is comparable to Western European countries by GDP per capita. It is a service-oriented country, with 79 per cent of GDP generated by the financial, real estate and corporate services industries. However, Australia is under a trade deficit with a high proportion of manufacturing exports in which commodity exports account for more than 60%.
As a result, the entire economy is sensitive to changes in commodity prices. Analysis of trade partners is important because Australia’s major trading partners’ economic downturn or rapid growth greatly affects Australia’s import and export demand. Japan and ASEAN are the most important importers of Australian goods. The Association of Southeast Asian Nations includes Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand, and Vietnam.
Australia maintained strong growth by solidifying the foundation of “strong domestic consumption” and was able to withstand the past economic crisis. Consumption has been steadily increasing since the 1980s. Therefore, consumer spending is an important economic indicator that should be watched as a signal to confirm the impact of the economic slowdown on Australia’s domestic consumption during the global economic downturn.
Reserve Bank of Australia
Determines Monetary Policy
The Reserve Bank of Australia (RBA) is the central bank of Australia. The Monetary Policy Committee determines monetary policy to achieve the targeted goals.
The government has set an unofficial consumer price inflation target at an annual rate of 2 to 3 per cent. The RBA believes that the key to sustainable economic growth in the long term is inflation control, which maintains proper monetary value.
Inflation targets also provide rules for determining monetary policy and provide guidelines for private-sector inflation expectations. This increases transparency in central bank policies. If inflation or inflation expectations exceed 2 to 3 per cent, traders will expect the RBA to implement a tight monetary policy.
Monetary policy decisions include setting the overnight lending rate in the currency market. Borrowers and lenders in financial markets are affected by these monetary policies (but not just by monetary policy) because changes in overnight lending rates affect various other interest rates.
1. Central Bank Interest Rate
The central bank interest rate is the RBA’s target for open market manipulation. This interest rate is on overnight loans between financial institutions, which is closely related to market capitalization. Changes in monetary policy directly affect the financial system’s structure and affect the value of the currency.
2. Interest Rate Maintenance – Open Market Manipulation
The purpose of open market manipulation is to keep the central bank’s interest rate close to the target by providing liquidity to commercial banks. If the central bank wants to cut interest rates, it could increase the supply of short-term repurchase agreements at lower interest rates than general interest rates. If the central bank wants to raise interest rates, it will raise interest rates by reducing the supply of short-term repurchase agreements.
The redemption agreement is a transaction in which the commercial bank sells the securities to the RBA after agreeing to buy the same amount of securities again on the specified date in the future. This structure is similar to a mortgage and Repo deals have very short maturities from one day to a few weeks.
Australia introduced a floating exchange rate system in 1983. RBA can intervene in the exchange rate market if market volatility increases excessively. RBA observes the trade price index and the cross-exchange rate with the dollar closely. Market intervention is aimed at stabilizing the market environment rather than achieving the goal of the exchange rate.
3. Monetary Policy Conference
The RBA discusses potential changes in monetary policy on the first Tuesday of each month except January. After all meetings, it issues a press release explaining the justifiable reasons for the change in monetary policy and releases a statement regardless of whether interest rates change.
The RBA publishes semi-annual monetary policy statement in May and November. And on February, May, August and November quarterly reports on the economy and financial markets are published. These reports are recommended to be scrutinized as you can detect potential signs of monetary policy change.
Key Characteristics of Australian Dollars
1. Product-Related Currency
Historically, the Australian dollar has had a strong relationship with commodity prices, especially gold prices, reaching nearly 80 per cent. This stems from the fact that Australia is the world’s third-largest gold producer. As a result, the Australian dollar benefits when commodity prices rise, but the Australian dollar also falls when commodity prices fall.
Higher commodity prices will heighten inflation concerns, and the RBA will raise interest rates to curb inflation. However, gold prices tend to rise in the age of uncertainty in the global economy or political issue. If the RBA raises interest rates in this situation, Australia will be more vulnerable to uncertainties.
2. Carry Trade Effect
The Australian dollar is most commonly used in-carry trading because of its high liquidity and interest rate. Carry trading is the purchase of high-interest monetary assets by selling or borrowing low-interest currencies. The Australian dollar rose 95 per cent against the U.S. dollar from 2001 to 2007.
Many foreign investors have been looking for high-yield investments when the return on the stock investment is low. Carry trade will continue as long as there are opportunities. If global central banks raise interest rates and the interest rate gap narrows between Australia and other countries, AUD/USD will be hit by the carry-trade liquidation.
3. Drought Impact
As commodities account for most of Australia’s exports, Australia’s GDP is very sensitive to the climate environment that damages agricultural activity. For example, 2002 was a challenging year for Australia to find a severe drought, and it hit the Australian agricultural sector tremendously.
Agriculture is vital as it accounts for 3% of Australia’s GDP. The RBA estimates that a decrease in agricultural production could directly reduce GDP growth by 1%. In addition to exports, the drought has indirectly affected other aspects of Australia’s economy. Retail operations in rural areas and industries that provide services to agriculture, such as wholesale and transportation sectors, are negatively affected by drought.
However, it is worth noting that Australia’s economy is showing strong growth right after the drought. The 1982–1983 drought initially reduced GDP, but then increased by 1 to 1.5%. The 1991–95 drought caused GDP to fall 0.5–0.75% in 1991–92 and 1994–95 but eventually rose 0.75%.
4. Interest Rate Difference
Professional traders in the Australian dollar are watching the difference between interest rates in Australia and short-term interest rates in other developed countries. This is because the premium of Australian dollar short-term bonds can be determined to what extent they are higher or vice versa than short-term bonds. These differences can be a good indicator of potential changes in currency value.
Traders use this difference to indicate potential currency movements because investors are always looking for high-yield assets. This is especially important for carry-traders who want to enter or liquidate their positions depending on the interest rate gap between global bonds.
Australia’s Important Economic Indicators
1. Gross Domestic Product
Gross domestic product is the sum of the market value of all goods and services generated in Australia. GDP is calculated by households, businesses, governments, and net foreign purchases (export-income). The GDP deflator is used to convert the total output measured at the current price to the base year’s fixed-dollar GDP. This indicator is used to determine the Australian business cycle’s current location, where high growth rates are often interpreted as inflation, and low or negative growth suggests economic recession or sluggish economic growth.
2. Consumer Price Index
The Consumer Price Index CPI measures changes in the prices of goods and service baskets every quarter, which account for a high percentage of expenditures by the CPI population sample group (such as large urban households). The basket includes a wide range of goods and services, including food, housing, education, transport, and health. CPI is an important indicator because it is determined based on this index, a measure of inflation.
3. Balance of Goods and Services
The index is a measure of Australia’s international trade in goods and services based on its balance of payments. The import and export of general goods are mostly derived from international trade statistics based on Australian tax records. The current account is the trade balance plus the service balance.
4. Personal Consumption
This includes purchasing durable goods as well as non-durable goods. However, it does not include expenditure on housing purchases and capital expenditure on private entities. It is important to watch because personal consumption can drive the recovery of the Australian economy.
5. Producer Price Index
The Production Price Index PPI is an index group that measures the average change in domestic producers’ sales prices. The PPI tracks price changes in almost all commodity-producing industries in the domestic economy, including agriculture, electronics, natural gas, forestry, fishing, manufacturing, and mining.
The foreign exchange market focuses on how the seasonally adjusted PPI and PPI indexes have changed from monthly, quarterly, semi-annual, and year-on-year. Australia’s PPI is published quarterly.