Trading in forex and looking to make returns on moves in the Australian dollar requires understanding the factors that drive the price of different currencies. Whether you’re aiming to trade AUD against the US dollar, Canadian dollar or Japanese yen, these are the price drivers you need to know.
The exchange rate of the Australian dollar (AUD) is subject to a variety of factors that can influence its value in relation to other currencies in the forex market. Understanding these factors is critical for anyone looking to get involved in forex trading.
What Are Interest Rate Differentials?
Interest rates play a pivotal role in determining the value of a currency. The difference in interest rates between two countries can significantly impact their currency exchange rates. This concept is known as interest rate differentials.
Tip: Cash assets are liquid and mobile and easily moved from an account in one country to one in another.
How Australia’s interest rate policies impact its currency strength
Australia’s interest rate policies are shaped by the Reserve Bank of Australia (RBA), which adjusts rates to control inflation and stabilise the economy. When Australia’s interest rates are higher compared to other major economies, it attracts foreign investors seeking higher returns on investments.
An influx of foreign capital increases demand for the AUD, thereby strengthening its value. Conversely, if the RBA lowers interest rates, the AUD might weaken as investors look elsewhere for better returns.
For instance, during periods when the RBA has maintained higher interest rates than the US Federal Reserve, the AUD has typically appreciated against the US dollar. This is because investors shift their capital to Australia to benefit from the higher interest returns.
Tip: RBA interest rate announcements are often accompanied by statements that provide insights into future monetary policy.
Commodity Prices
Australia is a major exporter of commodities such as iron ore, coal and natural gas. The prices of these commodities can significantly affect the value of the Australian dollar. Foreign counterparts looking to purchase Australian commodities need to buy the AUD currency to process the transaction.
The link between Australia’s export commodities and AUD valuation
When global demand for Australia’s key exports is high, prices tend to rise, leading to increased revenue for the country. Conversely, a drop in commodity prices can weaken the AUD as foreign buyers require fewer Australian dollars to buy the resources they need.
Economic Performance and Stability
The overall economic health of a country is a critical factor in determining its currency value. Various economic indicators can provide insights into the economic performance and stability of Australia, influencing the AUD exchange rate.
Economic indicators that traders should monitor
Traders should pay attention to key economic indicators such as GDP (Gross Domestic Product) growth rates, employment figures and inflation rates. These indicators provide insights into the economic health of Australia and can influence investor confidence in the AUD.
- GDP growth: A strong GDP growth rate indicates a healthy economy, which can attract foreign investment and strengthen the AUD.
- Employment rates: High employment levels suggest economic stability, potentially boosting the AUD as investors view the economy as robust.
- Inflation rates: Moderate inflation is generally positive for a currency, while high inflation can erode purchasing power and weaken the AUD.
Monitoring these indicators helps traders anticipate potential movements in the AUD exchange rate and adjust their trading strategies accordingly.
Sentiment and Speculation
The sentiment and speculative activities of traders can also influence the AUD exchange rate. Market sentiment reflects the overall attitude of investors towards a currency, which can be swayed by various factors, including geopolitical events and economic forecasts.
The role of global economic sentiment in Australian dollar volatility
Global economic sentiment can cause fluctuations in the AUD, even if Australia’s domestic economic indicators remain stable. If investors perceive global economic instability, they may move their assets to safe-haven currencies such as the US dollar or the Swiss franc, causing the AUD to depreciate.
Speculation also plays a role, as traders often make decisions based on anticipated future movements rather than current economic data. This speculative trading can lead to increased volatility in the AUD exchange rate.
Tip: Monitor global demand trends for Australia’s key exports, as they can provide early signals of potential AUD movements.
Final thoughts
The Australian dollar’s exchange rate is a reflection of complex economic interactions. By understanding these factors, forex traders can better predict movements and make informed decisions that align with their trading strategies.
Recognising the impact of interest rates, commodity prices, economic performance and market sentiment is crucial for anyone looking to trade with the AUD.
Learn more about forex trading by visiting the eToro Academy.
FAQs
- Can I track upcoming interest rate decisions from the RBA?
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Yes. Upcoming announcements from the RBA are logged on the Schedule of All Releases page of the bank’s site. Other Economic Calendars also log upcoming announcements from the RBA and other central banks.
- How do commodity prices specifically impact the Australian dollar?
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Commodity prices impact the Australian dollar by affecting the country’s export revenues. Higher commodity prices increase export income, strengthening the AUD, while lower prices can weaken it due to reduced economic growth prospects.
- How does buying AUD allow investors to gain exposure to Asian markets?
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If strong economic growth in Asia results in increased demand for commodities and an upward move in AUD, then investors can benefit by buying AUD. Accordingly, weaker growth in Asia could see the value of AUD fall. This proxy investment avoids some of the operational risks associated with investing directly in Asian markets — for example, buying Chinese stocks.
This information is for educational purposes only and should not be taken as investment advice, personal recommendation, or an offer of, or solicitation to, buy or sell any financial instruments.
This material has been prepared without regard to any particular investment objectives or financial situation and has not been prepared in accordance with the legal and regulatory requirements to promote independent research. Not all of the financial instruments and services referred to are offered by eToro and any references to past performance of a financial instrument, index, or a packaged investment product are not, and should not be taken as, a reliable indicator of future results.
eToro makes no representation and assumes no liability as to the accuracy or completeness of the content of this guide. Make sure you understand the risks involved in trading before committing any capital. Never risk more than you are prepared to lose.