Economic stars in alignment for Aussie dollar

The forces pushing the Australian dollar higher are easier to identify than those that might drag it down.

That does not mean it will head skyward without pause. But all stars are certainly aligned nicely, at least for the time being.

Last week, Nomura's global economic team released forecasts showing the Australian dollar, currently just under 92 US cents, rising to one US dollar - which would be a 28-year high - later this year.

The classical driver of the Australian dollar is the price of Australia's export commodities on world markets.

Although down from the boom prices seen just ahead of the global financial crisis, commodity prices in foreign currency terms are still more than double their levels of five years ago, before the China-led boom began in earnest.

Last year, China produced 18 tonnes of steel per second.

This year, despite a slower growth rate, output could hit 20 tonnes per second. It is a safe bet that demand for Australia's coal and iron ore will remain strong for a while yet. It is not always clear exactly how commodities act on the exchange rate.

Export revenues are important, but probably less so than the capital inflows as investors search for higher returns in Australia's equity market.

That search has not gone unrewarded. In the past year the share market gave investors a gross return of 46 per cent in Australian dollar terms, and 92 per cent in US dollar terms.

That sort of return does not so much attract investors as generate a fan base. And then there are interest rates.

Typically, when the Australian economy is being pumped up by a commodities boom, the Reserve Bank of Australia (RBA) trying to deflate it using higher interest rates.

In this case, the relative appeal of Australia's short-term rates is enhanced by the weakness in other advanced economies and the low interest rates - near zero in the US and Japan - being used to try to get them up and walk again.

The "carry trade" in this environment looks like a canny long-term investment rather than the daily punt that it is.

Domestically, there is little to worry about. Inflation is tame and economic growth "might already have been running at, or close to, trend for a few months", according to the Reserve Bank of Australia (RBA) last week.

What's more, the country's in is a better budgetary position after a couple of years of fiscal stimulus than most nations were in before they started trying to spend their way out of recession. It all looks like a recipe for ongoing gains for the Australian dollar.

But there are some caveats. One is that the Australian dollar is already relatively high.

There is a limit to how high it can go and still be at a level justified by economic fundamentals.

Against the US dollar it is 27 per cent above the average since the exchange rate was allowed to float freely in December 1983.

Consistent with that, those Nomura forecasts show the Australian dollar's rise running out of steam once it reaches one US dollar.

Another caveat is that the major economies will eventually recover, prompting their central banks to start jacking up interest rates and eroding the short-term interest rate advantage enjoyed by the Australian dollar.

A better performance in global share markets could cause some capital currently in the Australian share market to be repatriated.

And the Chinese growth explosion cannot be guaranteed to proceed without interruption.

Financial instability, over-investment in industrial capacity, social unrest or monetary tightening to restrain inflation could all generate discontinuities in the growth path, even though at this stage it looks to be rising smoothly into the distant future.

And there is no guarantee the fiscal restraint developed economies will need to employ to rein in their ballooning debt will not push the world back into a slowdown.

But for the time being, those are just risks to an outlook which looks to be unusually supportive for the Australian dollar.