Currency Profiles: Guide to Developed Countries Currencies

Australia

Economic Overview

Australia's GDP for 2002 is close to US$400Bln. The economy is relatively small, but on a per capita basis is comparable to many industrialized Western European countries. Australia has a service-oriented economy with close to 79% of GDP coming from industries such as finance, property and business services. However, the country has a trade deficit, with manufacturing dominating the country's exporting activities. Rural and mineral exports account for over 60% of all manufacturing exports. As a result, the economy is highly sensitive to changes in commodity prices.

Japan and the ASEAN (Association of Southeast Asian Nations) are the leading importers of Australian goods. However, Australia in the past, experience much spillover effects of general Asian weakness. This resilience stems from Australia's sound foundation of strong domestic consumer consumption.

Monetary & Fiscal Policy

The Reserve Bank of Australia (RBA) is responsible for the monetary policy of Australia. Decisions on monetary policy are based upon consensus within the committee.

The RBA's charter states that the mandate of the Reserve Bank Board is to focus monetary and banking policy on ensuring:

(a) the stability of the currency of Australia;
(b) the maintenance of full employment in Australia; and
(c) the economic prosperity and welfare of the people of Australia

In order to achieve these objectives, the government has set an informal consumer price inflation target of 2%-3% per year.

Monetary policy decisions involve setting the interest rate on overnight loans in the money market. Other interest rates in the economy are influenced by this interest rate to varying degrees, so that the behavior of borrowers and lenders in the financial markets is affected by monetary policy (though not only by monetary policy). Through these channels, monetary policy affects the economy in pursuit of the goals outlined above.

Cash Rate: This is the RBA's target rate for open market operations. The cash rate is the rate charged on overnight loans between financial intermediaries. As a result, the cash rate should have a close relationship with the prevailing money market interest rates. The chart below shows their relationship. Changes in monetary policy, directly impacts the interest rate structure of the financial system.

Open Market Operations: The focus of daily open market operations is to keep the cash rate close to the target, by managing money market liquidity provided to commercial banks. If the Reserve Bank wishes to decrease the cash rate, they would increase supply of short dated repurchase agreements at a lower interest rate than the prevailing cash rate, which would in essence decrease the cash rate. If the Reserve Bank wishes to increase the cash rate, they would decrease supply of short dated repurchase agreements, which would in essence increase the cash rate. A repurchase agreement involves a cash taker (commercial bank) selling securities to a cash provider (RBA), while agreeing to repurchase the securities of the same type and quantity at a later date. This structure is similar to a secured loan, whereby the cash taker must pay the cash provider interest. These repo transactions tend to have very short maturities ranging from one day to a few weeks.

Since 1983, Australia has had a floating exchange rate. The Reserve Bank of Australia may undertake foreign exchange market operations when the market threatens to become excessively volatile or when the exchange rate is clearly inconsistent with underlying economic fundamentals. The RBA monitors a trade-weighted index (TWI) as well as the cross-rate with the US dollar. Intervention operations are invariably aimed at stabilizing market conditions rather than meeting exchange rate targets.

The RBA meets every month (except for January), on the first Tuesday of each month to discuss potential changes in monetary policy. Following each meeting, the RBA issues a press release outlining justifications for their monetary policy changes. They also publish a monthly Reserve Bank Bulletin. The May and November issues of the Reserve Bank Bulletin include the Semi-Annual statement on the Conduct of Monetary Policy. The February, May, August, and November issues contain a Quarterly Report on the Economy and Financial Markets. It is important to read these bulletins for signals on potential monetary policy changes.

Important Characteristic of the Australian dollar

  Commodity linked currency

The AUD$ has an 80% correlation with commodities and more specifically, gold prices. The reason is because Australia is the 3rd largest gold producer in the world and gold represents approximately $5 billion in exports for the nation each year. As a result, the AUD$ benefits when commodity prices increase. Of course, it also decreases when commodity prices decline.

  Carry trade effects

Australia has one of highest interest rates among the developed countries. With a fairly liquid currency, the AUD$ is one of the most popular currencies to buy for carry trades.

  Interest rate differentials between the cash rates of Australia and the short-term interest rate yields of other industrialized countries are closely followed

Interest rate differentials can be good indicators of potential money flows as they indicate how much yield premium AUD$ short term fixed income assets are offering over foreign short term fixed income assets, or vice versa. This differential provides traders with indications of potential currency movements, as investors are always looking for assets with the highest yields

  Severe weather conditions such as droughts, negatively affect Australia's economy

Since the bulk of Australia's exports are commodities, the country's GDP is highly sensitive to severe weather conditions that may damage the country's farming activities. This is especially important because agriculture accounts for 3% of the country's GDP. The RBA estimates that the "decline in farm production could directly reduce GDP growth by around 1 percentage point." Aside from exporting activities, a drought also has indirect effects on industries that supply and service agriculture.

Important Economic Indicators for Australia

  Gross Domestic Product (GDP)
  Consumer Price Inflation (CPI)
  Balance of Goods and Services
  Private Consumption
  Producer Price Index (PPI)

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