The Australian Dollar (AUD) remains on its back foot against the US Dollar (USD) on Tuesday, although the pair has bounced up above 0.7050 after hitting session lows near 0.7040 following a monetary tightening pause by the Reserve Bank of Australia (RBA). Governor Bullock has pushed the Aussie moderately higher in the press release, leaving the door open for further rate hikes.
The Australian central bank left its benchmark interest rate unchanged at 4.35% as widely expected on Tuesday, following three consecutive rate hikes this year. Governor Michelle Bullock affirmed during the press conference that monetary tightening is still on the table, which provided some support to the Aussie. The AUD(USD, however, is facing pressure from a somewhat stronger US Dollar, as the enthusiasm for the US-Iran deal faded.
Bullock warns that inflation is still too high
Governor Michelle Bullock showed a hawkish stance in the press conference following the bank’s decision. Bullock stated that Australia faced an inflationary problem even before the war in Iran started and welcomed the peace deal, although, in her opinion, price pressures might not respond in the expected way and “we might have to do more”.
Beyond that, the Australian Bureau of Meteorology (BoM) has officially declared El Niño active and warned that it might be the strongest ever, according to its models. El Niño is associated with less rainfall and higher temperatures and tends to have a negative impact on agriculture and weigh on Australia’s GDP.
Lastly, the US Dollar is regaining some ground as the initial optimism about the peace deal in Iran turned into caution, with markets awaiting further details on the agreement. Key issues like traffic through the Strait of Hormuz remain unclear, and the possibility of a re-escalation has not been completely ruled out.
RBA FAQs
The Reserve Bank of Australia (RBA) sets interest rates and manages monetary policy for Australia. Decisions are made by a board of governors at 11 meetings a year and ad hoc emergency meetings as required. The RBA’s primary mandate is to maintain price stability, which means an inflation rate of 2-3%, but also “..to contribute to the stability of the currency, full employment, and the economic prosperity and welfare of the Australian people.” Its main tool for achieving this is by raising or lowering interest rates. Relatively high interest rates will strengthen the Australian Dollar (AUD) and vice versa. Other RBA tools include quantitative easing and tightening.
While inflation had always traditionally been thought of as a negative factor for currencies since it lowers the value of money in general, the opposite has actually been the case in modern times with the relaxation of cross-border capital controls. Moderately higher inflation now tends to lead central banks to put up their interest rates, which in turn has the effect of attracting more capital inflows from global investors seeking a lucrative place to keep their money. This increases demand for the local currency, which in the case of Australia is the Aussie Dollar.
Macroeconomic data gauges the health of an economy and can have an impact on the value of its currency. Investors prefer to invest their capital in economies that are safe and growing rather than precarious and shrinking. Greater capital inflows increase the aggregate demand and value of the domestic currency. Classic indicators, such as GDP, Manufacturing and Services PMIs, employment, and consumer sentiment surveys can influence AUD. A strong economy may encourage the Reserve Bank of Australia to put up interest rates, also supporting AUD.
Quantitative Easing (QE) is a tool used in extreme situations when lowering interest rates is not enough to restore the flow of credit in the economy. QE is the process by which the Reserve Bank of Australia (RBA) prints Australian Dollars (AUD) for the purpose of buying assets – usually government or corporate bonds – from financial institutions, thereby providing them with much-needed liquidity. QE usually results in a weaker AUD.
Quantitative tightening (QT) is the reverse of QE. It is undertaken after QE when an economic recovery is underway and inflation starts rising. Whilst in QE the Reserve Bank of Australia (RBA) purchases government and corporate bonds from financial institutions to provide them with liquidity, in QT the RBA stops buying more assets, and stops reinvesting the principal maturing on the bonds it already holds. It would be positive (or bullish) for the Australian Dollar.
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