19 Apr 2010

By Alistair Cotton, Corporate Dealer, Currencies Direct

The Australian dollar continues to be a top choice for currency investors. Several factors have combined to make the Aussie dollar the best performing major currency over the past 12 months, with an increase of over 30% versus the US dollar.

First, Australia has a commodity-based, export-driven economy with a strong central bank. Australia is entering their 19th consecutive year of economic growth, after avoiding the global downturn of the past two years. Their close trading ties to China have allowed them to weather the global crisis much better than their G10 counterparts. The strong and steady growth in China has kept commodity prices climbing, supporting the raw material exports of Australia and underpinning their currency. Growth in the Australian economy rose in the fourth quarter at the fastest pace in two years as GDP climbed 0.9% from the third quarter and 2.7% year over year. The economy is expected to grow 3.25% this year and then 3.5% in the following two years, good sustainable growth rates in an uncertain global climate.

The biggest jobs boom in more than three years and a surge in business confidence is further evidence that the economy is already growing at or close to trend. Employers added 194,600 jobs in the five months through January and sent the unemployment rate to an 11-month low of 5.3%, which is close to half that in the US and the Eurozone and significantly below the UK. While the February employment numbers came in less than expected, it nonetheless was a positive figure and marked the 5th straight month of gains. Economists are expecting steady declines in the jobless rate to 4.7% by year-end and many see wage pressure intensifying once it falls below 5%.

The strong economy has allowed the Reserve Bank of Australia to begin increasing interest rates, making their currency even more attractive for investors. The RBA was the first G10 central bank to raise rates, and has increased rates 5 times in the past 6 central bank meetings. Governor Glenn Stevens said the move was a ‘further step’ toward returning interest rates to average levels. He is trying to cool a housing market that continues to look as if it is in danger of overheating. With growth likely to be around trend and inflation close to target over the coming year, it is appropriate for interest rates to be closer to average.”

These interest rate increases have pushed up the yield differential between Australia and the US, UK Eurozone and Japan. High interest differentials encourage ‘carry trade’ investments, where investors borrow at the low rates available in Japan or the US and invest the proceeds into the higher yielding currency of Australia. Carry trades pushed the Australian dollar to double-digit returns versus the US dollar in 2007 and 2009 and should continue to encourage investment flows into the Aussie dollar throughout 2010.

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