The falling Australian dollar explained

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The Australian dollar has fallen from 81 US cents at the start of 2018 to below 72 US cents recently (with a few hiccups along the way). A lower dollar is bad news if you’re planning a trip to the United States, but what does it mean for the rest of us? 

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Well, it really depends. A lower dollar is good news for Australian companies selling goods and services overseas because it gives them a price advantage against global competitors. However, it’s not so good news for importers because they will pay more for goods made overseas. That means higher prices for consumers and higher inflation. 

There are two sides to every story and that’s especially the case for exchange rates between pairs of currencies – the Aussie dollar’s fall is also the story of the greenback’s rise.

So, what’s driving the Aussie dollar?

“The US dollar is stronger than we thought, commodity prices and China’s economic growth are weaker than we thought, and US interest rates keep going up,” explains Joseph Capurso, Director of FX Strategy and International Economics at CommBank.

CommBank recently reduced its forecast for the Australian dollar to 72 US cents by December 2018 and 75 US cents by December 2019 for four main reasons:

1. The US Dollar is rising against most currencies

“The US economy is in strong shape, inflation is on target at 2%, its labour market is strong, the equity market is strong and tax cuts have resulted in US multinationals bringing money back to America,” says Capurso.

2. Commodity prices have been falling

A slight softening in global economic growth and escalating trade tensions will reduce demand for commodities. As a result, Australia’s terms of trade – the value of our exports minus imports – could drift lower over the next few years.

“The Australian dollar trades as a commodity currency so it has followed commodity prices lower,” explains Capurso.

3. China’s growth is slowing

“Part of the reason for falling commodity prices (and the lower Australian dollar) is that China’s economy is softening faster than we thought,” says Capurso.

Falling Chinese interest rates and a depreciating currency are putting downward pressure on other Asian currencies – including ours – to remain competitive.

4. The widening interest rate gap

The US Federal Reserve has been lifting interest rates since 2015, from near zero to a range of 1.75–2.0%, with further increases pencilled in for the remainder of this year and 2019. The return to more ‘normal’ rates is due to solid growth in the US economy and unemployment hovering below 4%.

By comparison, Australia’s official cash rate has fallen over the same period and sits at an historic low of 1.5%. The next move is likely to be up, but not until there are clearer signs of economic growth.

“We think the Reserve Bank will delay lifting rates until November next year,” says Capurso.

Higher US interest rates relative to Australia makes the US a more attractive destination for yield-seeking investors. As foreign money flows into the US market, demand for the US dollar increases and its value rises.

The Australian dollar against other foreign currencies

While the Australian dollar’s slide against the greenback grabs all the attention, it hasn’t moved nearly as much against other currencies. Against a basket of foreign currencies, tracked by the trade weighted index (TWI), the Aussie dollar has eased around 3.5% this year, compared with a fall of more than 7% against the greenback.

Currency markets are notoriously difficult to predict, but even if the Aussie dollar has further to fall it would provide a welcome boost to our famers, manufacturers and miners. And if you’re headed overseas, there are plenty of places where the Aussie dollar stretches further.

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Important: This article has been prepared without taking account of the objectives, financial or taxation situation or needs of any particular individual. Before acting on the information, you should consider its appropriateness to your circumstances and if necessary, seek appropriate professional advice. Any information used in this article is for illustrative purposes only. Past performance is no guarantee of future performance.