The Drivers of Australian DollarExchange Rate
The exchange rate is one of the most iconic elements of the economy of any country, the most visible to the citizens.
While such percentages, which determine the essence of economic relations, may elude people’s attention, the exchange rate of the country’s main currency against other international currencies is almost always visible in various media. In addition, in today’s world, in which international transactions are commonplace, a massive number of people constantly use this ratio.
That is why it is extremely important to understand the drivers of the exchange rate and its possible impact on a particular currency. The purpose of this paper is to analyze the Australian dollar and the factors that influence its exchange rate.
What is the Interest Rate?
The first factor that has a massive impact on any exchange rate is the interest rate. In this case, the ratio set by the central bank, or Reserve Bank of Australia, is meant by this term, from which all other banks already set the ranges of annual rates (Banton, 2020). This rate is an extremely important parameter that affects the entire economic situation.
Although the interest rate is not a defining parameter, a higher interest rate usually increases the currency’s value compared to countries where the interest rate is lower (Lioudis, 2019). This relationship is based on the attractiveness of the money and the investment market: the higher the interest rate, the greater the demand for the home currency, and vice versa.
However, it is necessary to consider other factors of market attractiveness: political and economic stability, the balance of trade, and others.
Australian Interest Rate
The general principles described earlier also apply to the Australian dollar.
As you can see from the statistics, over the past ten years, the interest rate of the Reserve Bank of Australia has been steadily declining. This situation is observed not only in Australia; it is a general trend to stimulate economic growth by involving investors in riskier ventures (Lynch, 2020).
Nevertheless, in Australia, this ratio remained relatively high most of the time, which corresponded to a low level of risks and internal problems and was an indicator of a sufficiently high level of investment.
However, over the past two years, the interest rate has dropped sharply from 1.5 to 0.1 percent (Atkin et al., 2021). While the interest rate itself does not have a massive impact on the exchange rate, as stated earlier, there are several key points here.
Affecting Exchange Rate
First of all, it is the sharp decline that was carried out in just two years that is indicative. In such conditions, with a sharp reduction in the interest rate, the attractiveness of the currency is reduced, which is reflected in a decrease in the exchange rate.
Secondly, along with the value of the interest rate, the difference with the interest rates of other countries also decreases, which makes Australia less attractive to investors.
Finally, such a substantial decline means that the economy will not return to its previous values soon. Although the economy is in an early stage of recovery, it is still far from its completion (Verrender, 2021).
Therefore, it can be concluded that in the face of a sharp decline, the interest rate has become one of the main drivers of the decline in the Australian dollar’s attractiveness and exchange rate.
Atkin, T., Hartstein, I., & Jääskelä, J. (2021). Determinants of the Australian Dollar Over Recent Years. Bulletin. Web.
Banton, C. (2020). Interest rate. Investopedia.
Lioudis, N. (2019). How national interest rates affect currency values and exchange rates. Investopedia. Web.
Lynch, D. (2020). The lengthy era of rock-bottom interest rates leaving its mark on the U.S. economy. The Washington Post.
Verrender, I. (2021). Why interest rates are soaring and what it means for you. ABC News.