Happy Landings For Our Dollar

Sydney Morning Herald

Wednesday December 5, 2007

By John Collett

Our rising currency is good news for those about to head overseas - and it could get even stronger.

Strong commodity prices and high interest rates are driving the Australian dollar higher against most of the world's currencies. The $A has risen so much that some of the most popular holiday destinations are the cheapest they have been for 20 years. And the dollar is likely to get even stronger.

"We will continue to see some volatility ... but I think the broad trend is that the Australian dollar will remain pretty strong," says Shane Oliver, AMP Capital Investors' chief economist.

Among the biggest winners are those travelling across the Pacific. The $A is buying more than US85 cents, compared with just US77 cents a year ago. That's an increase of more than 10 per cent in the purchasing power of Australians visiting the US. The Australian dollar has recently pulled back against the US dollar after having reached US94c but there is no need to rush to lock in favourable exchange rates.

Oliver says further rate rises are on the cards to fight inflation, while the US is likely to cut rates to help stimulate its slowing economy. That will widen the interest rate gap between the two.

Interest rates are a big driver of exchange rates because international investors seek high-quality government bonds paying the highest rates. Increased demand for a currency lifts its price (exchange rate) relative to other currencies.

Oliver says the $A may fall slightly against the $US over the next few weeks but he expects the exchange rate to be even better in the new year, with a good chance the Australian dollar will reach parity with the US dollar.

It is not only in the US that Australians are finding their money goes further. There is a raft of bargain destinations this summer thanks to the strong currency.

The dollar has appreciated against the Hong Kong dollar by more than 10 per cent, which should not be surprising given the $HK is pegged to the US dollar.

Even in Britain, which is notoriously expensive for Australians, the $A is making some headway; it buys 43 pence whereas a year ago it bought 40p - an increase in purchasing power of more than 7 per cent.

Oliver says, over time, the Australian dollar will probably gain further against the pound as the British economy slows, led by a declining housing sector, and interest rates may have to be cut by the Bank of England.

JAPAN CHEAPEROne of the biggest increases in the purchasing power of the $A is against the yen. Three years ago it bought 80 yen; now it buys about 95 yen, an increase of more than 18 per cent.

The Japanese economy is slowing and interest rates there are already at 0.5 per cent compared with Australia's 6.75 per cent. But the yen is volatile. The main reason is the "yen carry trade". This is where international investors borrow Japanese yen at very low rates and invest in higher-yielding assets, such as Australian government bonds.

Whenever global investors get nervous about the outlook for global growth, typically sparked by fears the US economy is slowing, the carry trade reverses and there is less buying pressure for high-yielding currencies such as the Australian dollar.

A reversal in the yen carry trade occurred in the past few weeks and in August when the value of the Australian dollar dipped against the yen. The volatility means intending visitors to Japan must pay particular attention to the exchange rate and to the timing of changing their Australian dollars into yen.

The euro is the only major currency against which the Australian dollar has not increased in value. Oliver says that is because the euro is a big beneficiary when investors sell their US-dollar denominated assets. By virtue of the Europe's economic clout and liquidity, the euro is the main alternative currency to the greenback.

The Canadian dollar has also held steady against the Aussie. Canada, like Australia, is a major exporter of commodities and so its currency has risen against others. However, Oliver says the Canadian economy is heavily influenced by the US, whereas Australia's is more influenced by Asia, and slowing growth in the US will also slow the Canadian economy. Oliver is expecting the Australian dollar to appreciate against the Canadian.

There has also been little change in the exchange rate with the New Zealand dollar because the dominion is one of the few developed countries with higher interest rates than Australia. The $NZ is also a commodity currency and there has been a strong rise in the prices of "soft" commodities such as dairy products.

RISKY DESTINATIONSThe $A has appreciated significantly against the South African rand. It buys 6 rand, compared with 5.5 rand a year ago. Three years ago it bought 4.7 rand - so there has been a 28 per cent appreciation.

Deciding where to holiday will hinge on more than just a favourable exchange rate. On that basis alone, Zimbabwe would be the standout destination for Australian holidaymakers.

A year ago an Australian dollar bought about 190 Zimbabwe dollars but at the time of writing it is buying more than 26,000 Zimbabwe dollars. But inflation is running out of control there and if the rate of inflation is higher than the rate of appreciation of the Australian dollar, which is likely, the purchasing power of the $A will be less than it was a year ago.

Hyper-inflation is the least of the worries for those contemplating a visit to Zimbabwe. The Australian Department of Foreign Affairs and Trade warns: "The high level of criminal activity, the absence of rule of law and deteriorating economic conditions could lead to civil unrest at any time."

The Australian dollar has also appreciated 18 per cent against the Pakistani rupee over the past year and is 19 per cent higher against the Indonesian rupiah. Again, DFAT warns: "We advise you to reconsider your need to travel to Pakistan at this time due to the very high threat of terrorist attack, sectarian violence and the unpredictable security situation." The department has issued a similar warning for Indonesia, highlighting the terrorist threat in particular.

Oliver says the appreciation of the $A against just about all currencies, except the euro, should continue but there will be volatility along the way.

However, forecasting exchange rates is notoriously difficult. Some would-be travellers may take the view that a bird in the hand is worth two in the bush. Oliver says these travellers, especially those changing large amounts of Australian cash, could exchange half now and half later to cover the risk of a sudden reversal in the fortunes of the Australian dollar.

© 2007 Sydney Morning Herald

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