Dollar's slide in line with fundamentals

23 May 2012, 6:12 pm   -   Source: AAP

The foreign exchange market can be irrational at times but in this case the slide in the Australian dollar is consistent with the economic fundamentals

The foreign exchange market is the home of knee-jerk reactions and irrational responses to news.

But the Australian dollar's recent slide does not fit into any of those categories.

It peaked at just over 108.5 US cents in late February but reached 97.4 on Wednesday.

That 11 per cent fall was a hefty move in three months.

But it was consistent with the economic circumstances - not something you can always say about exchange rate movements.

It can be seen clearly as a belated adjustment to the price fundamentals that drive it up and down from year to year, notably export commodity prices which are down by eight per cent from their mid-2011 peak.

But there's more to it than that.

Traders are clearly factoring in a risk that the economy will take a battering.

That risk obviously emanates from Europe but would affect Australia partly via its effect on China's demand for minerals to feed its export industries, which are still oriented toward satisfying the West's demand for consumer goods.

But it would also hit the local economy through share prices, which affect business investment and the employment that goes with it.

And the world's share markets, including Australia's have fallen in recent months.

Then there's interest rates.

The cash rate set by the Reserve Bank of Australia has already been cut one percentage point since early November in response to the bleak outlook.

The futures market says it has another full percentage point to fall, to 2.75 per cent, by the end of the year.

Such an ultra-low rate by itself would be enough to pull the rug from under the Australian dollar, even without the kind of economic calamity calling for a cash rate at its lowest for over half a century.

  • Follow us: 
  • Follow us on Facebook
  • Follow us on Twitter
  • Follow us on Youtube