Australian Dollar softens on escalating Middle East tensions
- AUD/USD softens to around 0.7130 in Friday’s early Asian session.
- An escalation of the conflict in the Middle East underpins the US Dollar, a safe-haven currency.
- Markets expect the RBA to hike the Official Cash Rate in the May policy meeting.
The AUD/USD pair loses traction to near 0.7130 during the early Asian session on Friday. Renewed conflict in the Middle East provides some support for a safe-haven currency, such as the US Dollar (USD), against the Australian Dollar (AUD).
Bloomberg reported on Thursday that the US military intercepted two Iranian oil supertankers that tried to evade its blockade as Washington continues to stymie Iran’s shipping and Tehran threatens vessels in the Strait of Hormuz.
Later in the day, US President Donald Trump said that if Iran doesn’t move the oil, its infrastructure will explode. Signs of a prolonged war in the Middle East could boost a safe-haven currency such as the Greenback and create a headwind for the pair.
On the Aussie front, futures markets indicate a 72% probability of a 25 basis point (bps) increase to 4.35% at the May meeting. Westpac analysts expect the Reserve Bank of Australia (RBA) will hike rates again in May, June and August, which would take the cash rate to 4.85% following two earlier hikes this year. This would be the highest cash rate since November 2008.
Australian Dollar FAQs
One of the most significant factors for the Australian Dollar (AUD) is the level of interest rates set by the Reserve Bank of Australia (RBA). Because Australia is a resource-rich country another key driver is the price of its biggest export, Iron Ore. The health of the Chinese economy, its largest trading partner, is a factor, as well as inflation in Australia, its growth rate and Trade Balance. Market sentiment – whether investors are taking on more risky assets (risk-on) or seeking safe-havens (risk-off) – is also a factor, with risk-on positive for AUD.
The Reserve Bank of Australia (RBA) influences the Australian Dollar (AUD) by setting the level of interest rates that Australian banks can lend to each other. This influences the level of interest rates in the economy as a whole. The main goal of the RBA is to maintain a stable inflation rate of 2-3% by adjusting interest rates up or down. Relatively high interest rates compared to other major central banks support the AUD, and the opposite for relatively low. The RBA can also use quantitative easing and tightening to influence credit conditions, with the former AUD-negative and the latter AUD-positive.
China is Australia’s largest trading partner so the health of the Chinese economy is a major influence on the value of the Australian Dollar (AUD). When the Chinese economy is doing well it purchases more raw materials, goods and services from Australia, lifting demand for the AUD, and pushing up its value. The opposite is the case when the Chinese economy is not growing as fast as expected. Positive or negative surprises in Chinese growth data, therefore, often have a direct impact on the Australian Dollar and its pairs.
Iron Ore is Australia’s largest export, accounting for $118 billion a year according to data from 2021, with China as its primary destination. The price of Iron Ore, therefore, can be a driver of the Australian Dollar. Generally, if the price of Iron Ore rises, AUD also goes up, as aggregate demand for the currency increases. The opposite is the case if the price of Iron Ore falls. Higher Iron Ore prices also tend to result in a greater likelihood of a positive Trade Balance for Australia, which is also positive of the AUD.
The Trade Balance, which is the difference between what a country earns from its exports versus what it pays for its imports, is another factor that can influence the value of the Australian Dollar. If Australia produces highly sought after exports, then its currency will gain in value purely from the surplus demand created from foreign buyers seeking to purchase its exports versus what it spends to purchase imports. Therefore, a positive net Trade Balance strengthens the AUD, with the opposite effect if the Trade Balance is negative.
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