Australian dollar strength - just a short term improvement?

Exchange rates movements are very difficult to predict. The reason is that there are many short term influences that cause volatility and long term influences that determine a  'fundamental value' for a currency.

This week the Australian dollar has strengthened against the US dollar (US$). A relief for the many Australian travellers abroad? Maybe not. All currencies have got stronger against the US$ so Australians will only see a real difference if visiting the US itself.

In the short run the demand and supply of currencies is influenced by a number of factors, which can change quickly, such as commodity prices and interest rates. Once the market takes the view that a currency's value will change the speculative forces that are brought to bear make that change inevitable - at least for a while.

In the long run the theory of 'purchasing power parity' suggests that a currency's exchange value should reflect how many real goods and services will actually buy and the rate moves to equate that purchasing power. So the long run trend is set and the short run variations move around that.

If the theory of purchasing power parity applies to Australia then with the end of the mining boom Australia's dollar should have depreciated against other currencies since 2012. This is because Australians will be worse off as a nation.

The article from The Age looks at some of the recent influences on the Australian dollar. An excellent case study in demand and supply factors affecting exchange rates.

The Age article is here

This article has particular relevance to IB students  for exchange rates and is a possible IA article  For VCE students the article also provides essential reading on the influence of the exchange rates of economic goals and the standard of living.