Australian Dollar Surges Toward Parity After Reserve Bank of Australia Unexpectedly Raises Interest Rates, November 2, 2010
November 2, 2010 (Bloomberg) -- Australia’s dollar climbed toward parity with the U.S. dollar after the central bank unexpectedly raised interest rates for the first time in six months, spurring demand for the nation’s assets.
Australia’s currency was also bolstered by speculation that the Federal Reserve and Bank of Japan will take further monetary-easing measures this week, helping Australia expand its yield advantage. The Fed begins a two-day meeting today while the Bank of Japan meets Nov. 4-5. The “risk of inflation rising” remains, Reserve Bank of Australia Governor Glenn Stevens said in the statement following policy makers’ decision to raise the benchmark rate to 4.75%.
“Clearly the RBA (Reserve Bank of Australia) still has a tightening bias,” said Sue Trinh, a senior currency strategist in Hong Kong at Royal Bank of Canada. “In an environment where the Fed is mulling quantitative easing and talk of the Bank of Japan following closely behind and possibly even the Bank of England, the RBA sticks out.”
Benchmark rates in Australia, compared with equivalents as low as zero in the U.S. and Japan, attract investors to the South Pacific nation’s higher-yielding assets. The risk in such trades is that currency market moves will erase profits.
Response of AUD to Unexpected Interest Rate Change
In class we discussed the concept of efficient markets and, how under this model, asset price changes (i.e., spot exchange rates) will move quickly in response to “surprises.” The move by the Reserve bank of Australia (i.e., their central bank) was unexpected by the markets. Thus, when it took place, the spot exchange rate (AUD/USD) adjusted quickly. The Australian dollar rose as market now had to factor high higher relative interest rates in Australia relative to the United States. The FXStreet chart below shows the quick response of the AUD to the unexpected news as it rose from .9875 to .9980 within a matter of minutes (Note: the time on the chart is Australian Eastern Time).
CHART: AUD/USD EXCHANGE RATE AT TIME OF UNEXPECTED ANNOUNCEMENT
Major Central Bank Interest Rate Targets As of November 3, 2010
NOTE: Chart Refers to Reserve Bank of Australia