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Friday 16

November, 201810:56 PM



Loss of risk appetite weakens dollar as interest rates remain unchanged

Loss of risk appetite weakens dollar as interest rates remain unchanged

Australia woke up to a weakened dollar on Tuesday morning after world markets took a turn away from risk assets which are often grouped together with commodity currencies such as the Australian dollar.

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By Charles Bliss 03.07.2018

Australia woke up to a weakened dollar on Tuesday morning after world markets took a turn away from risk assets which are often grouped together with commodity currencies such as the Australian dollar.

The drop was a result of traders taking positions prior to Tuesday's Reserve Bank of Australia (RBA) statement on the interest cash rate. The expectation was that the rate would remain at 1.5%, which is a record low. Expectations were confirmed and the rate remained unchanged for the 23rd consecutive month.

This lack of interest rate movement has been seen as a warning that downside risks are growing in the domestic economy. One example is the widely reported fall in the inflated Sydney property market. There is an expectation among economists that the RBA will not look at raising interest rates until late 2019, with some predictions saying the rate will remain flat until at least 2020. A look at interest rate derivatives reveals that most investors in these markets are expecting the RBA base rate to remain at 1.5% for the rest of the year.

Monday's trading session in the US and Europe saw commodities, stocks and risk currencies on offer at reduced prices. This was seen as a result of the trade war fears – particularly between China and the US – that have been rife in world markets this year.

Inflation rates remaining lower than the RBA's target figure of 2% to 3% for the past five years is one reason given for the decision to maintain the 1.5% cash rate. Another reason is the high burden of personal and household debt that currently exists which the RBA sees as leaving householders ill-equipped to deal with any raises after years of increased borrowing, at least partly due to wage stagnation.

The RBA decision on interest rates has a strong bearing on currency markets. Usually a change in the interest cash rate is a response to a change in the inflation level. This has an impact on currency valuations because of its effect on the flow of capital internationally, which in turn is attractive for those trading in forex.

The AUD/USD exchange rate has fallen 6.2% so far this year, with this most recent fall forming part of a downward trend. While the exchange rate against the Great British pound edged slightly higher overnight, it is still down 4% this year. The pound was the only currency that lost against the dollar overnight – the dollar was down against all other currencies from developed countries.

Another reason for the focus on the RBA's ruling on interest rates is the decision taken last month to remove a line from its June meeting minutes which said the next move in the cash rate is likely to be up, not down. Much has been made of this deletion, even though it is not something that is usually brought up in statements from the Reserve Bank. Some were of the opinion that rates might move sooner than expected. However, other commentary from the RBA suggested the rates would remain the same. There was even speculation that the line suggested a fall in rates was possible.

Australians are now facing more difficulty in gaining access to credit as the cost of borrowing in US dollars following interest rate rises in the US filters through the US-dollar backed banking system as a result of changes in the US government's protectionist international tax reform policies. These policies are aimed at taking profits in US dollars back from the international banking system.

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