Last week's interest rate cut hasn't worked how the Reserve Bank intended it: The Australian dollar is sitting at almost US 77 cents, and rising.
In fact, according to The Australian Financial Review, analysts from Australia and New Zealand Banking Group (ASX: ANZ) think it could even rise above US 80 cents in the near future, which could weigh on a number of shares across the ASX. More on that in a moment…
Indeed, the Reserve Bank of Australia cut interest rates to a record low of just 1.5% last week as it aims to improve business conditions and bolster the rate of economic growth. The decision followed a lacklustre set of inflationary figures which was released by the Australian Bureau of Statistics late in July.
However, it was also intended to weigh on the Australian dollar. Although the currency declined marginally immediately after the decision was made public, it has since rocketed higher and is currently buying US 76.75 cents.
Why that's a bad thing…
A strong Australian dollar is considered a good thing for net importers (for example, retailers which purchase most of their products from international suppliers) as well as international travellers.
However, it has the opposite effect for net exporters as their products become less competitive on a global scale. In other words, it becomes more expensive for international customers to buy products priced in Australian dollars.
What's more, there are a number of ASX-listed businesses which generate a significant portion of their earnings overseas, including Westfield Corp Ltd (ASX: WFD) and Cochlear Limited (ASX: COH). When they repatriate their earnings back to Australia, a higher dollar results in lower reported revenues and earnings.
A high Australian dollar is also bad for Australia's own tourism industry, potentially impacting companies like Crown Resorts Ltd (ASX: CWN).
What's driving the AUD?
Although our cash rate is currently sitting at 1.5% (and could be headed lower), it is still higher than the interest rates offered by many other developed nations around the world.
Indeed, there are a number of companies on the ASX such as Commonwealth Bank of Australia (ASX: CBA) and Telstra Corporation Ltd (ASX: TLS) which offer monstrous yields compared to what investors could otherwise get in other markets – the pair offer yields of 5.5% and 5.7%, respectively.
While the Reserve Bank of Australia has thus far been hesitant to cut interest rates locally, other central banks around the world have been cutting theirs (sometimes into negative territory) while the US Federal Reserve has also been less inclined to hike their own interest rates. That has driven foreign investors back into the Australian dollar, pushing it higher.
Members from the RBA have indicated that they would prefer the Australian dollar to be trading for around US 65 cents – more than 15% below its current level. A decline in commodity prices could help force it towards that level, but otherwise, the RBA may be forced to cut interest rates even further to nudge it in the right direction.
Investor Takeaway
Forecasting the currency rate is an extremely complex task, and bordering on impossible to do with any consistency in the long-run. Nevertheless, while the US economy is progressing – albeit slowly – the Australian economy is facing a number of headwinds which I think will push the Australian dollar lower, over time.
