Where is the Aussie dollar heading?

The value of the Australian dollar has been fairly volatile of late. It has swung from the mid fifties to the eighty cent range in the last few years alone. So where is the Australian dollar headed?

Since January, the Australian dollar has fallen from US$0.76 to US$0.70 by March. And some are forecasting that this trend will continue. While the falling Aussie dollar may be good for exporters, farmers and for other Australian manufacturers competing with imports, it’s also good news for the Australian sharemarket as around 30 per cent of earnings from companies listed on the Australian sharemarket come from overseas. For consumers however, the falling Australian dollar means higher prices, and therefore the risk of an increase in inflation.  But why is the Australian falling and is this trend set to continue over the longer term?

The falling Australian dollar is a result of the fact that the difference between interest rates in Australia and those of other currencies will continue to reduce. While Australia’s interest rates have remained low over the last few years, they have been a lot higher than many other countries including Japan, the United Sates and much of Europe. This led to foreign investment in Australia in order to take advantage of the higher interest rates, which in turn led to a stronger demand for Australian dollars. However, as other countries increase their interest rates, the differential becomes less important to foreign investors and the demand for the Australian dollar drops.

Another reason for the fall in demand for the Australian dollar may be the fact that the New Zealand dollar has been falling due to increasing speculation that the Reserve bank of New Zealand will have to cut interest rates as recession fears grow. The Australian Dollar has been caught up in the selling of the New Zealand Dollar.

Where to for the Aussie dollar?
According to Dr Shane Oliver, Head of Investment Strategy and Chief Economist at AMP Capital Investors, “A longer term measure of the fair value for the Australian Dollar indicates fair value is around US$0.70. This is based on what economists call ‘purchasing power parity’”.

While US$0.70 may be considered fair value based on purchasing power parity, it does not mean that the Australian dollar will settle at this value, as markets are often subject to wild swings and fluctuations. Another effect on the Australian dollar will be whether the resources boom can sustain its momentum for any length of period. And while China continues to demand our resources, it seems that despite short term fluctuations, commodity prices will be likely to rise in the foreseeable future.

Dr Shane Oliver believes that “the recent weakness in the Australian Dollar is unlikely to represent the start of a renewed downtrend. Australian interest rates are likely to remain above global interest rates for the foreseeable future and commodity prices are likely to remain high. As such, our assessment is that the Australian dollar will remain in the US$0.68 to US$0.80 range.”

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