This article is extracted from Australian Financial Review July 17, 2015

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Author: Rose Powell
Australian dollar’s next stop? US65¢ predicted as commodity prices decline

by Rose Powell
Falling commodities prices have slammed the currencies of resource and agriculture-heavy economies, including Australia, where analysts are forecasting the dollar to
weaken further, possibly to US65¢.
Major fund manager BlackRock is forecasting a continued slide to US70¢ by the end of the year. Capital Economics went further, anticipating an even faster fall to
US65¢ by the end of 2016.
On Friday the Australian dollar was trading at US74¢, down 1.51 per cent in the past week.
The currencies of commodity-heavy economies such as Australia are the worst-performing this year as falling commodity prices pressuring similar countries New Zealand
and Canada to cut interest rates as markets ready for them to continue to drop.
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While Australia grapples with lower key commodity value such as iron ore, deteriorating commodity prices forced the Bank of Canada to lower its benchmark to 0.5 per
cent in a bid to stimulate the economy on Thursday night.
New Zealand is also expected to cut rates again, from 3.25 per cent to 3 per cent as dairy prices continue to decline.
“The dollars of Australia, New Zealand and Canada have been three of the worst-performing major currencies so far this year. Despite the fact that they have already
fallen a long way, we expect them to weaken further,” Capital Economics John Higgins said.
Commonwealth Bank chief currency strategist Richard Grace said the declining commodity prices were creating huge and sustained impact on the dollar and economy.
“The dollar is very sensitive to commodity prices,” Mr Grace said. “Commodity prices and terms of trade are the clearest long-run indicators for the Australian dollar
and economy.”
He added interest rates were likely to stay low or be cut again as the Reserve Bank of Australia (RBA) dealt with below-trend gross domestic product and softer
domestic demand that is placing upwards pressure on unemployment.
If the dollar declines too far, Australia’s terms of trade could become so steep that businesses cut back on importing new technologies, influencing their
international competitiveness, which flows through to employment concerns.
“Capital imports have been falling for a few years because mining investment has slowed so much,” Mr Grace said. “We’ve not seen a threshold with the dollar crossed
yet, but it would be difficult for retailers to raise prices amid upward pressure on unemployment.”
Commodity prices are likely to continue to decline. Last week, the International Monetary Fund revised down its forecast for global growth, indicating the glut of
commodities is likely to push prices down as demand slows.
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“Financial markets are pricing in about an 80 per cent chance of an additional interest rate cut [in Australia] by February 2016,” Mr Grace said.
Capital Economics is anticipating an interest rate cut of 0.5 per cent to 1.5 per cent by the RBA before the March 2016.
While Australia, Canada and New Zealand are preparing to cut rates, the United States and United Kingdom are likely to raise rates later this year, which would cause a
further decline in value for the Aussie.
The greenback reached a six-week high at the end of the week as the European Central Bank announced liquidity boosting measures for Greece.
Fairfax Media Australia
Assignment
From the article titled ‘Australian dollar’s next stop? US65¢ predicted as commodity prices decline’ (Australian Financial Review July 17, 2015), answer the following
questions.
(a) Briefly summarise the main issues discussed in this article? [Not exceeding 200 words] – (25 Marks)
(b) Using Demand and Supply model of exchange rate determination briefly explain how AUD is determined in the forex market, and what factors influence its
fluctuations. – (15 Marks)
(c) Using exchange rate data from Reserve Bank of Australia and graphs (monthly data of last three years) analyse the movement of AUD relative to that of the US
dollar? Is it in line with the world commodity price movement during this period? Are there any other factors contributing to this behaviour of the Australian dollar?
– (25 Marks)
(d) Do you think that the AUD will fall as low as US 65C by the end of 2016? Justify your answer. What advantages do you think Australia will have in such a scenario?
– (15 Marks)
(e) If the market rate is US 65C then what action could the Reserve Bank of Australia take in order to maintain the exchange rate at US 70C, and what side effects
might this action have on the Australian economy? Do you think that such actions would be effective? – (20 Marks)
Word Limit: 2000 words maximum. Word count (excluding references) must be provided. Excess words will not be marked.
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Instructions
1. This assignment is marked out of 100 and is worth 25 per cent of overall marks. 2. At least 4 relevant references are required regarding the issue featured in your
allocated topic. 3. Turnitin Report: It will be compulsory for all students to submit the written assignment (final version) into the Turnitin system before submitting
the hard copy to the tutor. Students are encouraged to submit drafts of the assignment before the due date, enabling students to check their referencing and rectify
any issues before submission of the final version. a. In the absence of the submission of the Turnitin report, a zero mark will be awarded for this assignment task.
b. A similarity index of less than 10 per cent is expected in your assignment. Zero tolerance applies for plagiarism 4. Hand in your hard copy of the assignment to the
tutor on or before Week 8 of Trimester 3. Penalty applies for late submission.

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