As the Australian economy grapples with surging inflation rates, senior account manager from Market Haven, Mike Lucas, explains that this can take a toll on forex rates. Considering how the exchange rates have been quite volatile over the past two years, this shouldn’t come as a surprise. Investors are especially concerned about how they should deal with the situation, but to create an effective game plan, it’s important to understand the link between inflation and foreign exchange.
Both values have a negative relationship, so increasing inflation can result in a drop in the currency’s value against other currencies. When the total cost of developing, producing, and supplying products and services in a country increase, it’s less competitive compared to global prices. And since exports drop during years with higher inflation rates, the demand for AUD reduced in global markets.
Inflation Factors That Influence Forex Trading
A country’s inflation levels can affect various economic indicators, such as its GDP. Consequently, this can impact forex markets. The GDP is a crucial macroeconomic parameter that helps assess the country’s financial health. It shows whether the country’s economic growth is increasing or declining. Australia’s GDP is reaching an upwards trajectory of around 0.6 per cent, but the RBA is focusing on curbing the 7 percent inflation.
How Interest Rates Influence Exchange Rates
The fluctuating interest rate of a country can directly affect the demand for domestic currency. An attractive interest rate can encourage investors to move their capital in and out of a country since interest rates indicate the rate of return on savings and investments. This can influence the demand for the domestic currency. In the case of the AUD, the RBA has plans to increase the interest rate in an effort to bring down inflation. Of course, this effect isn’t always guaranteed, and it doesn’t happen in a vacuum. Rather, it depends on several other aspects as well.
Trading During Periods of Increased Inflation
Although the domestic currency’s value decreases in times of high inflation, investors should always assess the central bank’s response to surging price levels. Taking up a bullish or bearish position before understanding the central bank’s stance could be unwise in the long run.
In March, the RBA had a meeting to reiterate its stance on tightening inflation by increasing interest rates. The US had a similar approach last year when, despite the high inflation rates, the Federal Reserve increased the target interest rate seven times.
This was part of an attempt to reduce growing price levels, and it helped the value of the dollar appreciate by over 12 percent. Considering how the Federal Reserve intends to increase interest rates further in 2023, it’s likely that the USD will grow stronger.
As a senior account manager, Mike Lucas of Market Haven predicts that as long as the Australian economy successfully evades a recession, the value of AUD could potentially appreciate. Therefore, it’s best that investors know about the current policies that central banks are enacting. Additionally, they should view monthly consumer price index reports for foreign exchange.
