DEUTSCHE BANK: Australia's Interest Rates Are Supporting The Dollar Amid The Iron Ore Price Fall

After Westpac changed its mind on interest rates, and the Reserve Bank’s release of an optimistic minutes, the Australian dollar was — briefly — above 91 US cents today.

The currency’s strength, even in the face of a collapse in iron ore and copper prices, is defying the wishes of RBA governor Glenn Stevens, who recently told Parliament he still thought the AUD should be somewhere around 85 cents.

There are many reasons why this might be the case. But one of the primary drivers of the Australian dollar’s strength in the past — and again now according to Adam Boynton at Deutsche bank in Sydney — is the interest rate differential between Australian and US rates.

Boynton says even though the iron ore price collapsed recently, and the terms of trade are down sharply, that “the terms of trade is an important driver of the currency over the long-run, over the short-run interest rates appear more important”.

Taking it one step further Boynton says it is interest rates that hold primacy, noting: “we find evidence that moves in spot iron ore prices only impact the currency in the near-term if they are accompanied by shifts in interest rate differentials.”

So with interest rates low around the world, and with a likely next move higher in Australia keeping the interest rate differential high, the Aussie is supported.

Boynton says you can add in “signs of a pick-up in the domestic economy – our Australian data surprise index is the strongest across the G10 – and a robust gain in employment in February mean that the AUD can probably continue to look through weakness in iron ore prices.”

We might be hearing that the Aussie Dollar remains “high by historical standards” from the RBA for a while it seems.

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