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How does a strong AUD achieve the same effect as rising interest rates?

Discussion in 'Business, Investment and Economics' started by helpme, Jul 20, 2017.

  1. helpme

    helpme

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    I fail to understand the link between strong AUD and rising interest rates. Why do they achieve the same effect?

    Suppose an Australian sits on huge mortgage debt after buying several Sydney properties. When interest rates rise, he will be squeezed hard. When AUD strengthens, nothing serious happens to him financially. Maybe he might even enjoy cheaper lifestyle as a result of cheaper imports. He will have more money to spend thanks to strong AUD. So, why should strong AUD and rising interest rates achieve the same effect?

    Can the more learned forummers explain? Thanks.

    https://www.bloomberg.com/news/arti...ives-reserve-bank-a-rate-hike-it-doesn-t-want

     
  2. skyQuake

    skyQuake

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    Higher rates = foreign demand for AUD. Why leave money in USD/JPY/EUR at essentially 0% when you can earn 2% in AUD?
    The inflow/demand pushes the AUD up
     
  3. Quant

    Quant

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    That 2.7% bond yield return doesn't compensate for the 10% appreciation in AUD in 2017 for foreigners . Whilst the AUD has been the strongest currency against USD this year its just as much USD weakness as the other .
     
  4. craft

    craft

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    Compensate?? Both are positives.
     
  5. Klogg

    Klogg

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    In theory, the lower the value of the AUD against other currencies, the more demand for domestically produced goods/services against those that are imported. Put simply, imports are more expensive, things we produce here (and exports to other countries) are cheaper.
    So, if you want to incentivise people to buy Australian products, you make them cheaper relative to other products - this can be done by making the AUD cheaper (as per above).

    Taking this one step further, a cut or rise in interest rates would then translate to higher or lower inflation, because a weaker AUD means more money spent on the same thing (when talking about imports) and more money received for exports.

    This then links in with skyQuake's post - the demand/supply arrangement for the currency. As rates rise relative to other currencies, then the yield (reward) for holding that particular currency is more enticing. However, when the base rate attached to holding the USD rises relative to ours, it makes the AUD less attractive, and all things being equal should result in a fall in the exchange rate.



    If you narrow your assessment to just mortgages, then you're right, there's no direct impact from a higher AUD. But, these things don't exist in a vacuum, as per Charlie Munger:



    So the next question is - how does this actually effect mortgage holders if it doesn't impact them directly? Well, the answer is obviously, rates.
    All else being equal, when the Federal Reserve raises rates, the AUD should fall relative to the USD. If the AUD falls, inflation increases. Should inflation exceed the RBA's target band, they'll increase the cash rate to reduce inflation.
    Increased cash rate flows through to banks, which flows through to the interest rates on loans and deposits.


    This is the standard set of ideas, but macroeconomics has so many moving parts that it rarely ever follows the script...
     
    Skate likes this.
  6. Quant

    Quant

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    My mistake , in a rush as usual .
     
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