AUD/USD: Australian Dollar boosted by anticipated rate rises

It now takes 74 US cents to buy one Australian Dollar (AUD/USD), up 5.7% from 70 cents at the start of February.

The Australian economy is in its own league compared to that of other western financial systems. The fiscal futures of its 26 million-strong population are dictated strongly by commodity cycles and the fortunes of its largest global trade partner, China, which accounts for a third of its global trade.

But right now, the biggest factor influencing the currency’s direction comes from inflation, slow wage growth, and the sky-high housing market.

Australian Dollar: interest rates

The Reserve Bank of Australia (RBA) has an inflation target of 2-3%. But with headline inflation running at 3.5%, pressure to increase the cash interest rate from its record low of 0.1% is rising. The UK and USA have both already moved from record low rates.

However, Bank governor Philip Lowe argues Australia is ‘closer to the point where inflation is sustainably in the target range…but we are not yet at that point.’ However, he accepts ‘it is plausible that the cash rate will be increased later this year.’

The governor is keen to delay rate rises until wage growth strengthens, with wages only increasing by 2.3% last year. KPMG Chief Economist Brendan Rynne thinks this it will be August before rates increase, saying ‘it will be sometime before the RBA will consider they are achieving “sustainable increases” and therefore upwards movement in the cash rate is justified.’

However, with the supply chain crisis exacerbated by Russia’s war in Ukraine, Lowe believes that the supply chain issues that were ‘gradually being resolved’ will now worsen and ‘extend the period of inflation being above central banks’ targets.’

This could create a scenario where ‘the higher inflation would be more persistent and broad-based, and require a larger monetary policy response.’ And he emphasised that the Reserve Bank will ‘do what is necessary to maintain low and stable inflation in Australia.’

Commonwealth Bank Chief Economist Gareth Aird believes the Reserve Bank is ‘closer to raising interest rates than at any other time over the pandemic,’ and expects the cash rate to rise in June.

It’s worth noting that Australia’s dependency on commodities has ensured historically tighter monetary policy than in Western counterparts. With US and UK Consumer Prices inflation at 7.9% and 5.5% respectively, Australia’s central bank is unlikely to be complacent about the inflationary danger.