During the past two years, the Reserve Bank of Australia has held the official cash rate at a record low of 1.5 percent. This is despite an ongoing “trade war” between China and President Donald Trump that has led to financial instability in emerging markets. Among the key drivers for the Australian dollar is its strong interest rate differential with the US dollar. However, economic variables such as the price of commodities, global equity markets, and overall economic growth also affect its value.
The AUD/USD exchange rate has been in a bit of a tailspin lately. The currency has lost around 11% of its value against the US dollar so far in 2021. The Australian economy has improved, albeit at a slower pace than anticipated. In addition, the country’s inflation rate reached the highest level in almost two decades. The RBA has cited concerns about inflation and growth in recent months. It is almost certain that the bank will leave the official cash rate at 2.0 percent, though it could choose to hike the rate to 25 basis points during the September and October meetings.
Aside from the RBA, the United States is also a major driver of the currency. The Fed is expected to announce its target cash rate on Friday. The Fed Chair Jerome Powell’s remarks may influence the Australian dollar’s direction. His comments may also indicate the underlying path of the Federal Open Market Committee’s rate plans. If the Fed’s rate plan becomes more dovish than previously expected, the Aussie Dollar’s strength will be tempered.
The Australian Dollar is a strong pro-cyclical currency. It depreciates when commodity prices fall and when risk aversion increases. When a pro-cyclical currency depreciates, it supports the domestic economy by reducing the unemployment rate. But when the currency appreciates, it serves as a safe haven.
The Australian Dollar has become closely tied to the global economy and global equity markets. The country’s economy has performed very well during the past six years, but the currency has been under pressure lately. It has fallen from its March highs due to the Chinese economy’s poor performance. A slowdown in the economy has partly self-inflicted because the Chinese government has been unwilling to loosen its Covid-19 restrictions. But the Chinese government has recently announced a 19-point stimulus plan to boost investment and infrastructure projects. It is estimated that the plan will add up to a trillion Yuan to China’s economy.
The US Dollar continues to gain ground because it has stronger economic fundamentals than the rest of the world. In addition, a front-loaded Fed interest rate hike may lead to a recession sooner. But the currency’s value is also driven by changes in Treasury yields and interest rate expectations.
The Australian economy has been bolstered by strong productivity gains. In June, the government raised its minimum wage by 5.2%. In September, the country’s inflation rate rose to 7.3%, the highest rate in nearly two decades. Consumer spending has become a key factor in the Australian economy, and this is a heightened concern. The cost of living has also increased, and this is driving higher wage inflation.