The Australian Dollar
Australia has a floating exchange rate, which means that the value of the Australian dollar changes according to demand and supply in the foreign exchange market. The Reserve Bank of Australia (RBA) manages the exchange rate by setting interest rates in overnight money markets, which then affect lending and borrowing throughout the economy.
The RBA aims to set the rate of interest so that it promotes maximum employment and economic growth, but not so low that it sparks inflation. The RBA also monitors the exchange rate to ensure that it remains aligned with Australia’s economic fundamentals and does not become excessively volatile.
This explainer explores some of the key drivers of the Australian dollar exchange rate and discusses how the RBA might decide to intervene in the foreign exchange market. It also provides information about when the RBA may choose to buy or sell Australian dollars and why.
Why the Australian Dollar is Important
The AUD is the official currency of Australia. It is widely used in international trade and accounts for about 7% of global forex transactions. The AUD is also one of the most popular currencies among forex traders, which makes it particularly important to understand how it works and how to trade it safely.
How the Australian Dollar Works
The AUD has been an effective currency since 1966 when the country formally replaced its pound sterling with the Australian dollar. The AUD is valued based on the prices of Australia’s natural resources and a number of government policies that encourage economic stability in the country.
When the Australian dollar is ‘dysfunctional’
The exchange rate of the AUD can be volatile when the market for Australian dollars becomes ‘one-sided’, meaning that there are far more sellers than buyers. This can result in a large depreciation of the Australian dollar in a short time.
‘Dysfunctional’ markets can lead to instability in the Australian dollar, and can make it more expensive to export and import goods from Australia. In these cases, the RBA might decide to intervene in foreign exchange markets to help reduce volatility and increase stability.
This could be done by purchasing or selling Australian dollars on the foreign exchange market to help boost the economy and bring down the exchange rate. It could also be done by raising or lowering the interest rate.
How the Australian Dollar is ‘Functional’
The Australian dollar is a ‘commodity currency’, which means that it can be traded for other currencies, such as those of Japan, China, and the United States. It is an important currency for many different kinds of businesses, including mining companies and tourism operations.
It is a popular currency amongst investors, with some of the largest investments being in Australian resources. It is considered a safe haven because it has relatively little exposure to other countries’ financial risks and is backed by a federal government guarantee.
The Australian economy has been improving over the past few years, which is encouraging some investors to take risk again. The Aussie AUD is up over 2.5% in the past week, but it is still close to two-and-a-half year lows of $0.6476. The RBA has increased interest rates for the second time this year and will probably continue to raise them in the future, as it tries to keep inflation on a steady pace.
