Project #3: Impact of Interest Rates on Exchange Rates Group #3: Kristin Olson Chris Kline Wiley McCreedy 6/21/09

As expected we see a general downward pressure on the exchange rate as interest rates decrease over the time period. This is seen from September 08 through March of 2009.

As the differential between the Federal Reserve and Australian Central Bank peaks in July 08 we see a downward trend in the exchange rate. This downward pressure continues until the differential decreases early 2009 and the Aussie sees a slight rebound.

-As we have already learned a country’s domestic interest rate is impactful on its exchange rate -The AUD (as seen in chart 1) shows upward movement with a higher interest rate and the opposite. -Since all else is NOT equal the relative differential between the Federal Reserve and Reserve Bank of Australia cash rates impacts the currency as well -The peak of this differential at 5% in July 08 brings downward pressure on the AUD until March 09. -Clearly, the Aussies must keep a close on on the Fed to ensure their differential does not exceed market expectations or may endure a fall in their exchange rate. (unless of course they want something like that for their export sector) Conclusions from the Charts

Australian Monetary Policy Meeting Reserve Bank of Australia met June 2, They decided to keep the cash rate at 3.00% for the time being considering it is their lowest since the 1960’s. -They believe that while economic conditions are poor globally, Australia because of its sound economic policy will see a less severe decline and an earlier rebound in economic factors than other major countries. -The biggest hit Australia has seen is in the commodities of iron ore and coal as their prices and demand have decreased with the global recession. -However, because of a great trade relationship with China they are seeing an increase in demand compared to competing countries.

Governor Glenn Stevens on June 4, Governor emphasized statements of the Reserve bank two days prior. -Emphasized the strength and promise of the Australian export sector -up 2.7 points in early 2009, rest of region significantly down -Attributes this increase to a solid relationship with China China imported 5% of Australian goods China imports over 20% of Australian goods. “The Board has not felt the need to cut our policy rate to the very low levels – effectively zero – seen in some other countries. There are two reasons. The first is that the situation we face is not as dire. The second is that the reduction in interest rates we have implemented has had a more direct effect on borrowers than in many other countries.” -Governor Stevens Australian Monetary Policy Speech

-It is clear that the Reserve Bank of Australia wants to keep interest rates low to increase domestic economic growth. As long as they don’t impact the successful (to-date) export sector this should maintain. -However the leveled out differential of interest rates has shown a strengthening of the AUD, and a higher AUD is not good for exports. -The Reserve Bank will need to watch the US Federal Reserve closely to maintain a differential that does not put upward pressure on the AUD, which may mean an increase or decrease in domestic rates, depending on what the US does. -If Australia wants be be a leader in the global recovery they may need to intervene on the foreign exchange market to keep the AUD down. Group #3 Speculation on Future Impacts

DATA: MONETARY POLICY: -Governor’s Speech and Board Meeting Minutes referenced Resources for Project