In the last two months the GBP/AUD has been on an aggressive decline that has taken the rate to the lowest point since January 2015. There are several reasons why this increase in strength has taken place even when the global economy has a fairly poor outlook.
The AUD is known as a commodity currency which means its predominant source of income as a nation is raw materials. Recently there has been a rise in the cost of Oil along with a significant jump in Iron Ore.
Sterling as of late has been struggling and is weakening against many currencies, this is mainly because investors have been taking there money out of the Pound. Interest rates in Australia are some of the best available in the world and savers can receive over 3% in the banking system. This has essentially opened the window for investors to loan money out in a currency with very low interest rates such as the Euro and invest their money in Australia allowing them to earn more than they pay for the loan. This practice known as carry trading can create a massively overvalued currency, which leaves the currency exposed to a sell-off should the interest rate change.
What are the implications of a strong AUD
The strong AUD represents a tough decision for the Reserve Bank of Australia (RBA) because there is increased costs for businesses and people alike who have to purchase goods in Australia. Due to the rate increasing so much some foreign businesses may hold off of purchasing goods in Australia because they now cost over 10% more than in previous months. This in turn can affect the amount of production required and potentially lower the price of the goods.
The RBA is mandated to keep the inflation rate for Australia between 2-3% if the AUD continues to strengthen there may be an interest rate cut to increase spending. If the RBA cuts rates that should encourage some people to spend rather than save as they get less for their money in a savings account.
Will the AUD strength continue?
The question on whether the AUD can still increase on its position will be different depending on currency. The AUD/USD could change rapidly if the US Federal Reserve Increase Interest Rates, it’s likely that the USD will gain back all of its lost ground. From the perspective of the GBP/AUD rate, it seems likely that the AUD will strengthen as Sterling has very little good news especially with the Brexit referendum outcome being uncertain.
There should however be given a consideration that Australia’s biggest trading partner China could cause the rate to be volatile. The Chinese economy and markets effect the AUD rate and if there is bad news from China the Aussie will suffer. There is so much global uncertainty with regards to China, their economy whilst growing at 6% a year is arguably underperforming and shrinking. Any major problems in China could see the AUD dramatically weaken in a short time.
Overall the AUD has made significant gains and it looks likely that they may continue, however in the world of financial markets anything can change quickly.