- In early Asian trading on Monday, AUD/USD remained in positive territory around 0.6555.
- U.S. PCE inflation rose 2.5% year-on-year in June, highlighting the improving inflation environment.
- A more hawkish stance from the RBA may support the Australian dollar.
In early Asian hours on Monday, the AUD/USD pair is trading in an uptrend around 0.6555. Growing expectations that the US Federal Reserve (FRB) will start cutting interest rates in September are weighing on the US Dollar (USD). Market participants will be keeping an eye on Australian retail sales figures on Tuesday. Attention will be on the Australian Consumer Price Index (CPI) and the Fed interest rate decision on Wednesday.
The U.S. personal consumption expenditures (PCE) price index rose 2.5% year-over-year in June, up from a 2.6% increase in May, according to data released Friday by the Bureau of Economic Analysis. The figure was in line with market consensus. On a monthly basis, the PCE price index was flat in May, but rose 0.1%.
U.S. core PCE inflation, which excludes volatile food and energy prices, rose to 2.6% over the same period, matching the May increase and beating expectations of 2.5%. The core PCE price index rose 0.2% month-on-month in June, up from a 0.1% increase in May.
The Fed has maintained its benchmark overnight interest rate at the current range of 5.25% to 5.50% since July last year. However, signs of subsiding inflation and easing in the labor market have led financial markets to expect three rate cuts starting in September this year, putting selling pressure on the US dollar and providing a tailwind for AUD/USD.
As for the Australian currency, a hawkish stance from the Reserve Bank of Australia (RBA) could limit further declines in the Australian dollar (AUD). The RBA is likely to postpone rate cuts as inflation remains elevated. The market is betting on a rate hike in the fourth quarter, which would reflect a roughly 50% chance of a rate hike in September or November.
Frequently asked questions about the Australian dollar
One of the most important factors for the Australian dollar (AUD) is the level of interest rates set by the Reserve Bank of Australia (RBA). As Australia is a resource-rich country, another important factor is the price of its largest export, iron ore. The health of the Chinese economy, its largest trading partner, and Australia’s inflation, growth rate, and trade balance are also factors. Market sentiment, i.e. whether investors are holding riskier assets (risk-on) or seeking safe havens (risk-off), is also a factor, and risk-on is positive for the AUD.
The Reserve Bank of Australia (RBA) influences the Australian dollar (AUD) by setting the interest rate levels at which Australian banks can lend to each other, which in turn influences interest rate levels throughout the economy. The RBA’s main goal is to maintain a stable inflation rate of 2-3% by adjusting interest rates up and down. Relatively high interest rates compared to other major central banks support the AUD, and vice versa. The RBA can also influence credit terms using quantitative easing and tightening; the former is negative for the AUD and the latter is positive for the AUD.
China is Australia’s largest trading partner, so the health of the Chinese economy heavily influences the value of the Australian Dollar (AUD). When the Chinese economy is doing well, it buys more raw materials, goods and services from Australia, which increases the demand for the AUD and makes it more valuable. The opposite is true if the Chinese economy is not growing as expected. Therefore, any surprises, positive or negative, in Chinese growth data often have a direct impact on the Australian Dollar and its pair.
Iron ore is Australia’s largest export, worth $118 billion per year according to 2021 data, with China being the main destination. Therefore, the price of iron ore can be a driving force for the Australian dollar. Generally, when the price of iron ore rises, the AUD also rises as the total demand for the currency increases. The opposite is true if the price of iron ore falls. If the price of iron ore rises, Australia’s trade balance is also more likely to be in surplus, which is also beneficial for the AUD.
The trade balance, the difference between the income earned from exports and the amount paid for imports, is another factor that affects the value of the Australian dollar. If Australia produces exports that are in high demand, the value of the Australian currency will only rise from the excess demand that arises from foreign buyers wanting to buy the exports and the amount they spend on buying the imports. Thus, if the trade balance is positive, the value of the Australian dollar will rise and if the trade balance is negative, it has the opposite effect.
