Causes of Exchange rate movements (Terms of Trade (Long term:…
Causes of Exchange rate movements
Inflation rate differentials: Movement in the inflation rate causes the RBA to act in the short term cash market in order to countercyclically conduct monetary policy. For instance, inflation rate outside the RBA's target band, in response to which the cash rate is increased. This leads to an increase in foreign demand for AUD and a subsequent currency appreciation due to higher rates of return. However, higher inflation rate as compared to the rest of the world increases the price of Australian exports in the global market, leading to decreased exports and therefore, decreased demand of the AUD and therefore currency depreciation
Interest rate differentials- ^ I.R > less competitiveness due to ^ production costs > depreciation. However ^ I.R > more investment > appreciation. Vice versa.
Foreign Direct Investment
Higher levels of investment lead to higher value in the Australian dollar
Global economic conditions (e.g. GCB increased demand for Australian exports, increased conversion to $AUD, appreciates $AUD)
Terms of Trade
Favourable movement in the ToT: X prices increase relative to M price, hence more volume of M for given volume of X.
Demand for domestic X increase, leads to increase in AUD
Tastes and preferences
On a supply side, Australia's demand for foreign g/s and imports reflects the availability of the AUD in foreign exchange markets and therefore a depreciation in the $A
Speculation from investors (speculation of appreciation > increased AUD demand > appreciation//speculation of depreciation > increased AUD supply > depreciation)
Expectations of currency movements
Increased investor sentiment means increased demand for the AUD
Political events e.g. ESDC, Trump. Impacts on sentiment of foreign investors; contaigen
Safe Haven effect: Australia has over two decades of uninterrupted growth. Investors expect a less volatile investment and a more safe return
Volatility and differential risk on the futures market can lead to the selling positions, leading to an increased supply of $A, therefore depreciating it's value.
Terms of Trade
Long term: Unfavourable movements result in increased competitiveness
Change in commodity prices. A rise in commodity prices generally mean high exports. E.g. Increase in iron ore prices during Resources Boom $5 billion to $63.5 billion from 2001-2011
Short term: Unfavourable movements decreases export revenue from lower volume of exports and lower prices of exports.
External shocks e.g. Brexit, ESDC, Trump (decreases investor confidence>decreased foreign investment> decreased currency demand> depreciation)
International competitiveness - lower prices lead to ^ exports, which appreciates $ due to ^ conversion to $AUD