• Greg Morgan

Interest Rates & The Aussie Dollar

Interest rates are a hot topic right now, with most experts expecting the cash rate to rise sooner rather than later. Along with domestic inflation and rising property prices, the expansion and contraction of the Aussie dollar will be a huge factor in the decision. While the Australian economy may be small by international standards, the Aussie dollar is among the most traded in the world. With price shifting significantly over the last few weeks, the Reserve Bank will be watching the dollar closely.

The Australian dollar has been range-bound for most of the year, but the situation has changed dramatically over recent weeks. After sitting between 72 and 74 US cents for most of the back half of 2021, it climbed to 75.5 US cents before dropping to around 70 US cents. This sharp movement has put it firmly on the main stage, with the local currency influencing the price we pay for imported products and affecting the rate of inflation.

According to AMP Capital's Shane Oliver, "If it falls 10%, then all things being equal, imported prices rise 10%, and they are about 20% of the CPI, so spread over a year, it would add 2% to prices." If it keeps losing ground at the current rate, it will add to existing, and pretty substantial, inflationary pressures. This has a direct impact on the cash rate, with higher inflation making the Reserve Bank much more likely to bring forward a rate increase.

Just how much the dollar rises or falls in 2022 depends on many factors, including the price of the nation's largest exports: iron ore, coal, and gas. It will also depend on the level of Australian interest rates compared to those in other nations, and the demand for their currencies. Additionally, it will be affected by the perceived health of the Australian economy, the global state of the pandemic, and how this affects anxiety on global financial markets.

As things currently stand, the price of commodities is under pressure, offshore interest rates are rising, and the pandemic is proving once again to be impossible to predict. This is rattling nerves on global financial markets and affecting trade volumes during what is traditionally a volatile time of the year. However, it's not all bad news according to Dr Oliver, with links between the dollar and import prices not as strong or reliable as they once were.

"It [the dollar] fell about 14% into the pandemic low last year, and inflation didn't fall much," said Dr Oliver, adding "And by earlier this year, it rebounded to $US0.80, but there was little impact on inflation. And it partly depends on the ability of companies to pass import price increases onto their customers." It's not all good news either, though, with the dollar falling during a time of pent-up consumer demand. Based on figures from the Melbourne Institute, monthly inflation rose 0.3% in November to 3.1% up for the year. While far from unsustainable, this rise definitely places the cash rate under pressure.

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