Aussie Dollar Slips as PBOC Holds Lending Rates Steady

Key Moments

China Policy Steady as AUD/USD Pulls Back

AUD/USD edged lower during Asian trading on Tuesday, slipping after two straight daily advances and changing hands near 0.6970. The pair stayed under pressure as the Australian Dollar held onto losses in the wake of the latest policy announcement from the People’s Bank of China (PBOC).

China’s central bank left its benchmark Loan Prime Rates unchanged, keeping the one-year LPR at 3.00% and the five-year LPR at 3.50%. The decision signaled no fresh easing impulse from China, a key consideration for investors focused on currencies linked to global growth.

RBA Commentary Keeps Rate-Hike Risks in Play

The Australian Dollar may find some support from recent hawkish rhetoric out of the Reserve Bank of Australia (RBA). Assistant Governor Christopher Kent raised doubts about whether current policy settings are sufficiently restrictive and pointed to indications that neutral interest rates are moving higher in Australia and abroad.

Kent indicated that a higher neutral rate could imply the current 4.6% cash rate is exerting less downward pressure on demand and inflation than previously expected, leaving scope for further policy tightening. Market participants are now focused on an upcoming speech by RBA Deputy Governor Andrew Hauser this week for additional signals on the central bank’s policy stance.

Fed Outlook: Markets Price a December Move

On the U.S. side, Federal Reserve Chair Kevin Warsh last week expressed confidence in the resilience of the U.S. economy but stopped short of indicating whether or when further rate hikes might occur.

Positioning in fed funds futures, as tracked by the CME FedWatch Tool, points to expectations that the Federal Reserve will keep rates unchanged at its October policy meeting. At the same time, traders are assigning an 82.8% probability to a rate hike in December.

USD Tone Softens as Fed Risks Reassessed

Dollar performance has turned more mixed as investors reassess the near-term path of U.S. monetary policy. Analysts at Scotiabank observe that the “USD is mixed to a little softer on the session as markets continue to reconsider near-term Fed tightening expectations,” adding that recent Fed communication has led traders to pare back the perceived likelihood of imminent policy actions.

Fundamental Drivers of the Australian Dollar

Several structural and macroeconomic factors play a central role in shaping the Australian Dollar’s performance in global markets. These include domestic interest rates, commodity prices, the health of key trading partners, and overall risk sentiment.

Interest Rates and RBA Policy

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, Iron Ore, and Trade Dynamics

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 for 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.