Australian Banknotes
The Reserve Bank of Australia is the only issuer of Australian currency banknotes. The bank takes care of the banknotes production, issue and termination. The Royal Australian Mint in Canberra produces the Australian coins.
Exchange Rates and Interest Rates
Exchange Rate is the price of an Australian dollar expressed in terms of another currency. The exchange rate plays an important part in considerations of monetary policy in all countries. However, the exchange rate has not served as either a target or an instrument of monetary policy in Australia since the currency was floated. The exchange rate is best considered as part of the transmission mechanism. It serves to buffer the economy from external shocks, such that monetary policy can be directed towards achieving domestic price stability and growth.
Interest Rate is the amount charged, expressed as a percentage of principal, by a lender to a borrower for the use of assets. Interest rates are typically noted on an annual basis, known as the annual percentage rate (APR). Interest is charged by lenders as compensation for the loss of the asset's use (e.g. Australian currency)
The relationship between interest rates and the exchange rate is inherently non-monotonic.
Graph 1: Exchange Rate Australian Dollar a$1 against US Dollar
The graph shows the exchange rate of Australian dollar against the United States Dollar from 2006 to 2009 quarterly. Based on the graph above, there had been a shift in the currency between the two countries from 2006 to mid of 2008. However the rate shows decline in mid 2008 before starting to rise again in 2009. The rise indicates that Australian has better value of currency compared to United State. There is an appreciation. The exchange rate against the US dollar depreciated much more than the trade-weighted index because the Australian dollar may have appreciated against most of the Asian currencies.
Graph 2: Australian Trade Weighted Index
The trade-weighted index or TWI is not a price in terms of a single overseas currency, but a price in terms of a basket of currencies. This is often a better measure of general trends in the exchange rate than any one bilateral exchange rate, such as that against the US dollar, since the Australian dollar could be rising against the US dollar but falling against other currencies – in such circumstances, the TWI will give a measure of whether the Australian dollar is rising or falling on average. Based on the graph above, similar to graph 1, there had been shift of TWI from 2006 to 2007 before decline in mid 2008, but later rise again in 2009. Against country such as United States, the Australian dollar has appreciated significantly over the years and only depreciated during mid 2008.
Graph 3: Australian Target Cash Rate 2006-2009 Quarterly
The graph above shows the Australian Interest Rate from 2006 to 2009 quarterly. From 2006 to 2007, there has been increase of interest rate in Australia until June 2008, where the rate started to decline heavily until mid 2009, before it had started to rise again.
The rise in the interest rate will lead to a rise in the value of A$ against other currencies (an appreciation), while the fall in the interest rate indicates the fall in the value of A$ against other currencies (depreciation). Other things being equal, an appreciation of the exchange rate will lead to a rise in export prices and fall in import prices to the Australia. This in turn would be expected to have an effect on the demand for both imports and exports. We would expect the demand for exports to fall as export prices rise or the opposite.
Interest Rate relationship with Exchange Rates
Based on the variables above, it is implied that the interest rate can influence the exchange rate. The reason behind is that interest rate influences the demand and supply of currencies on the foreign exchange markets. A good deal of the trade in foreign currencies is for speculative purposes - traders moving funds from one currency to another to take advantage of price movements or to take advantage of better returns in different countries.
A higher interest rate means a better return on bonds, gilts and other Government securities and will, therefore, tend to attract financial capital from overseas. A$ must be purchased in order to buy these assets. So, if Australia interest rates go up – or more importantly, are expected to go up – the dollar will tend to strengthen against other currencies, and vice versa. However high interest rates can also increase country's cost of currency and it will cost people more to do business in Australia.
Currency exchange rates are determined everyday in large global currency exchange markets. There is no fixed value for any of the major currency, all currency values are described in relation to another currency. The relationship between interest rates, and other domestic monetary policies, and currency exchange rates is complex, but at the core it is all about supply and demand.
Interest rates also influence the return or yield on bonds. Because, for example, Australian Treasury bonds can only be bought in Australian dollars, a high interest rate in the Australian will create demand for dollars in which to purchase those bonds. A low interest rate, relative to other major economies, will reduce demand for dollars, as investors move toward higher yielding investments. At least, this is true in normal periods of economic expansion.
The relationship becomes a bit inverted, however, when investors become highly risk averse. In periods of credit contraction or recession, money will tend to move into safer assets, driving down interest rates. The low yield on bonds then is a reflection of the demand for their relative safety and low credit risk, and not a deterrent. In late summer 2008 for example, the Australia dollar gained value against the United States even as interest rates in the Australia were significantly lower because the likelihood of Australia default on treasuries was deemed less than in US. The lack of a federal treasury-system meant responses to bank failure would be country-specific, keeping interbank lending rates in US at alarmingly high levels.
Interest rates can also have economic effects, which influence currency exchange. Following the idea of supply and demand, speculators favor the currency of economies that are expanding, creating a virtual cycle of appreciation. An economy who's GDP is rising faster than its monetary base is by default increasing the value of its currency, and this will likely be reflected in currency exchanges.
Conclusion
The relationship between interest rates and the exchange rate has been the focus of a spirited academic and policy debate for a long time. This assignment has developed a simple model to rationalize the mixed and often conflicting results that have been obtained by a large body of empirical work in this area. It has shown — both analytically and numerically — that the relationship between changes in interest rates (both the interest rate controlled by policymakers as well as the market determined interest rate) and the level of the exchange rate is inherently non-monotonic. Hence, there is no reason to expect to find a monotonic relationship between the two variables in the data.
References
The exchange rate and the Reserve Bank’s Role
Interest Rate and exchange rate statistic table
Economics fifth edition John Sloman with the collaboration of Mark Sutcliffe
Prentice Hall Financial Times
Edwards, S. and C. V´egh, 2000, “Banks and Macroeconomic Disturbances under Predetermined
Exchange Rates,” Journal of Monetary Economics 40, 239-278.
Interest Rate: relation with Exchange Rate
http://www.economicshelp.org/macroeconomics/exchangerate/factors-influencing.html