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What drives the value of our dollar?

Importers and exporters may pay the closest attention to the value of the Aussie dollar, but movements in the exchange rate affect us all. 

A rising dollar makes it less costly to travel overseas and decreases the local cost of imported goods. On the downside, it makes many of our exports more expensive for foreign buyers, making life harder for farmers and other exporters. 

The reverse applies in the case of a falling dollar, but movements in exchange rates don’t just influence our living costs. Most people with Superannuation will have a portion invested in overseas assets, and changes in currency values can also influence the performance of retirement savings – for better or worse.

So what are the main influences on exchange rates? Ultimately it comes down to supply and demand, and that is determined by a number of things:

  1. Interest rates. Imagine an American investor earning 1% interest on their money. They look across the Pacific and sees that she can earn 2% in Australia. Here’s an opportunity to double their income! To do so they need to buy Australian dollars, increasing demand for our currency and thus increasing its value against the US dollar. Exchange rates respond very quickly to both actual changes in official interest rates, and to expectations of where interest rates in different countries are heading. 
  2. Commodity prices. From wheat and wool, to coal, iron ore and natural gas, Australia produces a wealth of commodities. When demand for the materials we produce is high, more money flows into Australia, creating a flow on demand for our dollar, pushing it higher.
  3. The economy. If the economy is doing well, or even a bit too well, the Reserve Bank of Australia may raise interest rates to keep inflation under control, which takes us back to item 1. A strong economy may also attract overseas investment, creating another driver of demand for the Aussie dollar. 
  4. Politics. Elections and referenda can create a climate of economic uncertainty that investors, on the whole, don’t like. The Brexit vote provides a good example. Ongoing uncertainty about Britain’s exit from the EU drove down the value of the pound against most currencies, including ours. We’ll pay less to holiday in the UK; they’ll pay more for our wheat and lamb. 

But it’s not that simple

Other things can influence currency values, such as speculation or central bank intervention. There’s also a lot of interaction between the influences on exchange rates outlined above. For example, strong commodity prices may give a boost to the economy, which leads to higher interest rates. Throw in some political uncertainty add a touch of speculation and things quickly become very complicated. 

Armies of analysts are employed to sift through massive amounts of data in their attempts to figure out where different currencies are headed. However, given all the complexities it is perhaps no surprise that they often arrive at very different conclusions. 

So will the Aussie dollar rise or fall? History suggests flipping a coin may provide as useful an answer as following the opinions of ‘experts’.

If you want to look at options for global share investing that are not impacted by currency movement, i.e. they are “hedged” against it; speak to your Hudson adviser.

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