Dr Shane Oliver
Head of Investment Strategy and Economics and Chief Economist
Following its dramatic change of fortune in 2013, the Australian dollar (A$) has hovered in the US$0.87-0.95 range since the beginning of 2014, but where is it heading from here?
Broadly speaking, the A$ is seen as overvalued and is expected to depreciate. However, the timing of this is uncertain.
In the near term, supporting a higher A$ are near zero interest rates and easy monetary conditions in the US, Europe and Japan. These measures make it more attractive to park money in Australia because it has higher interest rates.
On the other hand, signals that the A$ may fall at some point include weaker commodity prices and an increasing likelihood that the Bank of England and the US Federal Reserve will start to increase interest rates before the Reserve Bank of Australia. In addition, the $A is considered overvalued (allowing for relatively high Australian costs and prices) and this is slowing the rebalance of the economy away from a reliance on mining investment.
The key issue which will influence the A$'s value compared to leading currencies, like the US dollar (US$) and the Great British pound (GBP), is when interest rates will begin to rise in those countries, narrowing the interest rate gap that Australia has over them.
The UK and US strengthen.
In terms of economic conditions, the UK economy is going 'okay' at the moment, as the housing market has rebounded significantly since the lows of the global financial crisis.
Recently, Bank of England Governor, Mark Carney, made headlines by stating that rates in the UK could rise sooner than investors appeared to be expecting.
Stronger economic conditions support an environment where the Bank of England is likely to raise rates sooner rather than later and it is expected to be one of the first major developed economies to do so.
Meanwhile, the US is also showing signs of more encouraging growth as the impacts of the harsh winter and other one-off's dampeners seen earlier this year fade. The US$ is expected to benefit from this improving economic performance and the expectation of interest rate rises in 2015.
What's the outlook?
When interest rates do begin to rise, it will begin to reduce the advantage of holding the A$ and exchange rates will adjust to favour the US$ and the GBP.
However, given that the A$ has already corrected some its significant overvaluation compared to commodity prices and interest rate differentials, we expect the eventual resumption of its depreciation to unfold over a run of years rather than via a sharp short term fall.
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