The Australian Dollar: A Global Currency?
Image Credit: Reserve Bank of Australia

The Australian Dollar: A Global Currency?

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Australia has long prided itself on “punching above its weight” in global sporting contests such as the Olympics. Now, the resource-rich nation of 22.6 million people and the world’s 12th biggest economy may see its currency do the same, with the Australian dollar forecast to join the world’s elite.

Once derided as the “Pacific peso,” the Australian dollar may by 2015 become an official global reserve currency, adding to underlying demand for a currency already considered overvalued by the nation’s exporters.

The International Monetary Fund reportedly plans to include the “Aussie” as well as the Canadian dollar in next year’s COFER (Currency Composition of Official Foreign Exchange Reserves) surveys, which currently consists of the U.S. dollar, Swiss franc, euro, pound sterling and Japanese yen.

The symbolic move is seen as the first step toward making the Aussie part of the IMF’s Special Drawing Rights (SDRs), which are used by central banks to calculate their obligations to the fund.

The bulk of global foreign exchange reserves are held in the five COFER currencies, and with foreign governments already holding an estimated A$60 billion worth of Australian dollars, demand from central banks around the world would likely swell.

A spokesperson for Australian Treasurer Wayne Swan welcomed the fund’s announcement as another vote of confidence in the economy.

“This IMF decision is yet more confirmation that Australia is seen as a safe haven for global capital and one of the most attractive investment destinations in the world,” a spokesman said.

“We’re one of only seven countries in the world with the gold-plated, AAA rating with a stable outlook from all three global ratings agencies – a coveted trifecta. While we know the high dollar makes life hard for some sectors of our economy, it also reflects our strong fundamentals during the ongoing and acute volatility experienced in the global economy.”

Analysts said the IMF move would make the Australian dollar a more credible investment, increasing its long-term value.

“It does enhance the credibility of the Australian dollar as a reserve currency,” RBS senior foreign exchange strategist Greg Gibbs told the Sydney Morning Herald, indicating that central banks may be encouraged to add to their Aussie holdings.

With more than US$10.5 trillion of official reserves held worldwide, diversification into currencies such as the Australian dollar is expected to have a large impact on international equity and bond markets.

Chase for yield

The Australian dollar has hit new highs in 2012 against the U.S. dollar amid a chase for increased returns from investors in lower-yield regimes such as Japan.

The proverbial Mr. and Mrs. Watanabe’s traditional “carry trade” buying has long helped buoy the Aussie. But with yields expected to remain low in Japan, Europe and the United States for the immediate future, the Australian currency has plenty of supporters.

The Aussie currently offers the highest yield among the Group of 10 economies, spurring buying by investors who welcomed the Reserve Bank of Australia’s decision in early November to leave its official cash rate at 3.25 percent.

Retailers have suffered from the strong currency along with manufacturers, mineral exporters and the tourism industry, with the Australian dollar trading well above parity with the U.S. dollar over the past year.

Yet while markets have priced in a 61 percent chance of a rate cut at the RBA’s next monetary policy meeting on December 4, lower rates may not weaken the international appetite for the Aussie.

“In the current environment, we doubt that modest interest rate cuts would have much impact on the exchange rate,” ANZ economists noted in the bank’s September research quarterly.

The bank noted the experience of Australia and New Zealand, which had both cut official interest rates yet “neither currency has shown any particular weakness as a result”.

“So long as core global bond markets provide minimal yield to investors and the credit environment remains questionable, the Australian dollar should continue to see volatility moderate. The old adage that the currency ‘goes up by the stairs but down by the elevator’ may no longer be appropriate,” ANZ’s FX strategist Andrew Salter noted.

Salter pointed to high commodity prices, investor and central bank diversification flows and the continued global deleveraging process as continuing to lend support to the Aussie.

Trade-related demand reportedly accounts for only a minor percentage of total trading in Australian dollars, making the currency subject to the whims of international investors and speculators.

Demand for the Aussie as a safe haven currency may further raise the floor under the floating exchange rate, preventing any softening of export demand or commodity prices from causing depreciation.

However, exchange rates are notoriously difficult to forecast, with a Bloomberg survey of 47 investment banks producing a range between US$0.82 and US$1.10 for the year ahead, with US$1.01 being the median forecast.

"Probably the worst forecast variable in economics is the exchange rate…the second worst one is probably the saving rate," RBA governor Glenn Stevens said in a speech recently.

Stevens also downplayed the impact of the IMF’s reclassification, saying the Aussie had already been a reserve currency for “quite a few countries” in Asia for some time.

Yet despite warnings from analysts at Morgan Stanley that the currency may have already peaked, it appears Asia’s favorite yield play is set to remain strong for some time to come.

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