Financial reporters suggested that fluctuating interest rates were responsible for the AUD/GBP
fluctuation described above, and that the AUD/NZD change was due to lower inflation in Australia.
Explain how the change in exchange rates could have been caused by those events.
Interest rates have a powerful influence on the exchange rate because of hot money flows.
Suppose you have £100,000 to save in a bank. If both Australia and UK have same interest rates (5%) it doesn’t matter where you save your money. However, if Australian interest rates increase (6%) and UK interest rates fall(4%). There is a clear incentive for investors to save in Australia and benefit from higher interest rates. Therefore, people need to buy Aus Dollars to save in Australian banks. British investors wills sell pounds to buy Aus Dollars This causes the value of Aus Dollar to rise against the British Pound.
- Note Australian interest rates are likely to be higher if the Australian economy has a higher rate of economic growth
If one country has a lower inflation rate, then its goods will become increasingly competitive and this will lead to increased demand for the currency.
Another reason for the appreciating dollar is the increased demand for commodities that Australia is producing. In recent months the price of many commodities such as precious metals has increased, this has increased demand for Aus dollars to pay for Australian exports