Exchange Rates

What is the exchange rate and how is it measured?

The price of the AUD in foreign currency, measured bilaterally (AUD/USD) or against a trade-weighted basket (TWI); set by supply and demand in the FOREX market since the float (Dec 1983).

What increases demand for and supply of the AUD?

Demand: (1) Exports (2) Capital inflows; Supply: (3) Imports (4) Capital outflows

What is notable about AUD trading?

Among the five or six most-traded currencies; most turnover is financial, not trade.

What are the "big 3" causes for short answers?

(1) Interest rate differential (2) Terms of trade (3) Economic growth (domestic or regional)

List the 8 causes of exchange rate movements.

(1) Interest rate differential (2) Domestic economic growth (3) Regional business cycle (4) Terms of trade (5) Investor confidence and sentiment (6) Global trade shocks (7) International competitiveness (8) Speculation

AUD/USD trend: what are the key levels and causes?

(1) Jul 2011: 1.10 peak (MBII: IR differential + ToT) (2) 2013–16: 1.05 → ~0.70 (end of mining boom, China slowdown) (3) Mar 2020: 0.55 (COVID flight to safety) (4) Feb 2021: ~0.80 (post-COVID ToT surge) (5) Apr 2025: 0.59, 5-year low (US tariff shock) (6) 2026: ~0.70–0.72 (RBA hikes vs Fed, commodity prices, weak USD)

Cause 1, interest rate differential: theory and stats?

Higher Australian rates raise returns on AUD assets, increasing demand; 2011 CR 4.75% vs Fed 0–0.25%, AUD peaked US$1.10 (July 2011); again supporting the AUD in 2026 (CR 4.60% vs Fed 3.75–4.00%)

Cause 2, domestic economic growth: theory and stats?

Strong growth and profits attract FDI and portfolio investment; Mining Boom I: AUD US$0.48 (2001) → US$0.98 (July 2008); unemployment ~4% by early 2008, but the strong dollar squeezed non-mining exporters

Cause 3, regional business cycle: theory and stats?

Slower partner growth cuts demand for exports and AUD; China's growth ~10% → ~6–7% (2012–16) as AUD fell ~US$1.05 (2013) → ~US$0.70 (2016); AUD is a proxy for Chinese demand (37% of exports)

Cause 4, terms of trade: theory and stats?

Higher export prices raise demand for AUD; iron ore ~US$100 → over US$200/t (2020–21), AUD 0.55 → ~0.80 (Feb 2021); ToT 106.5 (June qtr 2021); CA surpluses of $15–18b a quarter in 2021

Cause 5, investor confidence: theory and stats?

In crises investors sell "risk" currencies for safe havens (USD); AUD 0.69 → 0.55 (Jan–Mar 2020), then recovered to ~0.80 within 11 months

Cause 6, global trade shocks: theory and stats?

Trade shocks hit commodity currencies hardest; April 2025 US tariffs drove the AUD to a five-year low of US$0.5922; rebounded more than 12% to ~0.67 by Dec 2025

Cause 7, international competitiveness: theory and stats?

High costs and low productivity reduce export demand over time (slow, structural); unit labour costs +3.6% (yr to June 2026); labour productivity ~5% below peak

Cause 8, speculation: theory and stats?

Expectations can become self-fulfilling; AUD is ~6% of global FX turnover (BIS) though Australia is ~1.5% of world GDP†; AUD moved 0.59 → above 0.70 in under ten months (Apr 2025–Jan 2026)

Current (2026): why is the AUD appreciating and what does it do?

Rising differential (CR 4.60% vs Fed 3.75–4.00%), strong commodity prices, weak USD; AUD averaged US$0.71 (Aug 2026), best-performing G10 currency; buffer against imported inflation, holding trimmed mean at 3.6% for three straight months (to Aug 2026)

List the 4 effects of exchange rate movements.

(1) Exports and export revenue (2) Imports and inflation (3) Dutch disease (4) The BOP (J-curve, valuation effect)

Effect 1, exports: theory and stats?

Appreciation lowers the AUD value of USD-priced commodity exports; commodity prices +15.5% in SDR terms but only +5.8% in AUD terms (yr to Aug 2026); BOGS stayed in deficit (−$5.1b, June qtr 2026)

Effect 2, imports and inflation: theory and stats?

Depreciation raises import prices (cost-push), appreciation the reverse; Aug 2026 AUD rise left oil slightly cheaper in AUD despite Brent above US$90; in 2022 a ~US$0.62 AUD amplified inflation as CPI peaked at 7.8% (Dec 2022)

Effect 3, Dutch disease: theory and stats?

Boom-driven appreciation harms trade-exposed industries that didn't cause it (manufacturing, tourism, education); Ford (2013), Holden (2013), Toyota (2014) announced closures with the AUD above US$0.90; ~50,000 jobs lost†

Effect 4, the BOP: what are the stats?

(1) J-curve: AUD ~1.05 (2013) → ~0.70 (2016), BOGS sustained surplus from 2016–17 (2) Valuation: March qtr 2026 appreciation cut net foreign equity assets by $66.6b

Fixed exchange rate: pros, cons and example?

Pro: certainty for traders and investors; Cons: (1) loses MP independence (2) needs large reserves (3) invites speculative attack; Eg: Thailand's peg collapsed (July 1997) when reserves ran out, triggering the Asian Financial Crisis

Floating exchange rate: pros, cons and example?

Pros: (1) automatic stabiliser for growth and BOP (2) frees MP for internal stability (3) fewer reserves needed; Cons: (4) volatility (5) costly hedging (6) imported inflation (7) speculative spirals; Eg: AUD depreciated in 1997–98 and 2008, Australia avoided recession both times