The value of the Australian Dollar (AUD) is heavily influenced by the nation’s trade balance. Furthermore, the economic prosperity of China, Australia’s biggest trading partner, is extremely important. Australia’s trade balance is the difference between what it exports and imports. When the balance is positive, it acts to reserve strength to the currency, but a negative balance puts downward pressure on the currency. The Reserve Bank of Australia (RBA) has a key role to play in determining interest rates. These rates feed into the value of the AUD capital markets.
Australia’s economy has become deeply dependent on its trade relationship with China, in particular Australia’s export of raw materials on which China’s rapid industrialization has relied. The price movements of Iron Ore, Australia’s largest export commodity valued at approximately $118 billion annually, are pivotal in driving the AUD’s value. As China’s economy grows, its demand for Australian goods and services increases, further impacting the currency’s strength.
The Role of Trade Balance
Australia’s trade balance has long been a key bellwether of the country’s economic fortunes. When the nation sells to the rest of the world more than it buys from other countries, it results in a trade surplus. This would normally be a positive for the AUD. This relationship underscored the need to develop strong export markets.
The impacts of trade balances extend far beyond the math. They provide strong evidence of Australia’s solid economic performance, and they underscore global demand for Australian goods. When Australia experiences boom periods for its exports, especially commodities, riding on the back of rapidly industrializing countries, the AUD appreciates. On the flip side, when imports are higher than exports, the country’s trade balance becomes negative, which results in a depreciation of the currency.
Besides raw materials such as Iron Ore, many of Australia’s exports are agricultural products and services. This means that any ups/downs of these sectors could immediately affect the trade surplus/deficit and therefore the strength of the AUD in the short term.
The Impact of Iron Ore Prices
Iron Ore prices have a huge impact on determining the direction of the Australian Dollar value. Iron Ore is now Australia’s biggest export. As it is, fluctuations in its prices can easily swing the country’s trade balance. This is relatively straightforward, high prices for Iron Ore lead to a greater inflow of export revenue for Australia, strengthening the AUD.
China’s appetite for Iron Ore is directly linked to its manufacturing operations. The flip side of this is that when the Chinese economy is strong it buys more raw materials, boosting Australia’s export income. That’s because this increased demand causes the AUD to appreciate.
Iron Ore is a vital driver of Australia’s export economy. Consequently, any random fluctuation in global market prices will almost immediately be reflected in the trade balance and the strength of the currency. As such, keeping an eye on Iron Ore price movements is crucial for predicting future fluctuations in the AUD.
The Influence of Interest Rates
The Reserve Bank of Australia (RBA) controls the interest rate with an iron fist. Most importantly, it tangibly affects credit conditions itself by pursuing quantitative easing and quantitative tightening measures. By raising or lowering interest rates, the RBA controls inflation by aiming for a stable inflation rate at 2-3%. These monetary policy decisions are having a real, direct impact on the value of the AUD.
When the RBA cuts interest rates, it wants people to borrow and spend more money. Each of these would likely increase activity weakening the AUD since it lowers returns on investments denominated in the currency. On the flip side, raising interest rates can lead to a stronger currency by drawing in foreign investment looking for higher returns.
The RBA’s monetary policy decisions are usually heavily impacted by the prevailing outside economic conditions — Chinese conditions included. Positive or negative surprises in Chinese growth data can significantly affect market perceptions and expectations for interest rate changes, thereby influencing the AUD.
“Facing external uncertainty, (we) will stay committed to joining hands rather than throwing punches.” – China’s Foreign Ministry
Australia’s economic outlook, as it turns out, is inextricably tied to its relationship with China. As underscored by China’s Foreign Ministry here, the focus is on win-win cooperation in trade, not a trade war. This positive sentiment further emphasizes the need to keep strong trade connections to help both economies rebound.
At a time when China is trying to increase its own trading relationships, Australia stands to gain from greater demand for its exports.
“We will trade with more friends and become a stronger magnet for investment.” – China’s Foreign Ministry