Is the Recent Drop in the Australian Dollar Permanent?

This past fortnight the Australian dollar has tumbled against the British pound and US dollar (among others.) But is the drop permanent or might the AUD bounce back?

Peter Lavelle at foreign exchange specialist Pure FX - 28.09.2011.

The drop in the Australian dollar this past fortnight has been vertigo-inducing. The AUDGBP and AUDUSD exchange rates (to mention just two currency pairs) have dropped almost 7 cents since 16th September. But how come this has happened - and is the AUD going to regain strength?

In large part this drop has little to do with Australia itself (which remains fighting fit compared to its industrialised counterparts.) Instead the decline can be attributed to global factors. For instance this past week HSBC released its latest Chinese manufacturing PMI - revealing a sharp slowdown in Chinese output.

Output dropped to 49.4 in September (figures beneath 50.0 indicate contraction) following a 49.9 decline in August. Since the huge Australian mining industry is dependent on China this has stoked concerns that the boom could be set to stall - hence diminishing confidence in AUD.

In addition continuing debt problems in Europe are causing concern - as politicians struggle to prevent Greece defaulting. Last week Greek finance minister Evangelos Venizelos told journalists that Greece faces a 50.0% chance of defaulting - prompting investors to abandon commodity currencies (like the AUD) in pursuit of havens like the US dollar.

But is this Australian dollar weakness going to last?

Perhaps not. In fact there are already signs investors are returning to the AUD. In the past two or three days the AUDUSD exchange rate has gained half a cent as the markets seek higher returning currencies. (Since interest rates in Australia are so high - 4.75% compared to 0.25% in the US - investors receive higher returns on Australian investments. This encourages the markets toward the AUD.)

Hence the demand for greater returns could encourage AUD strength.

Of course global concerns are going to continue to dampen sentiment - Chinese output is set to decline as the global outlook deteriorates - but this might not be the last we see of the strong Australian dollar.

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