Aussie dollar levels with the greenback

The Australian dollar reached parity with its US counterpart this week. That was its strongest level since it floated in the 1980s. The trigger for the latest jump was an unexpected rise in interest rates to 4.75%. That move pre-empts a rise in inflation in the Australian economy, which grew by an annual 3.3% in the second quarter of 2010. The 'Aussie' has gained 11% against the US dollar this year.

What the commentators said

Australia appears to be "a conscientious objector" in the global currency war, said Peter Garnham in the FT. The Aussie's strength is due to comparatively high interest rates and a widening gap between Australian rates and global ones, thanks to the strong economy. That in turn is partly a commodities and China story. China is gobbling up Australia's raw materials, notably coal and iron ore. Indeed, Australia's terms of trade export compared to import prices are at a 50-year high.

Add in a recent improvement in investor sentiment, which favours commodity currencies, and you have "a potent mixture promoting a stronger currency", said Standard Chartered. But buying ('going long') the Aussie is hardly a risk-free trade. For starters, "a sharp bout of risk aversion has been the catalyst" for corrections in the past. These "are not gentle affairs". During the credit crunch the Aussie fell by 40% in three months.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

A bounce in the US dollar would also hit the Aussie, since it implies a decline in risk appetite and hampers commodities. Another potential problem is that the slowdown in advanced economies is likely to affect China, curbing demand there the decline in real exports has accelerated since June. Meanwhile, a house price bubble and sky-high household debt-to-income ratio of 164% are the key domestic worries. The long-term trend is nonetheless encouraging, and many analysts see further gains for now. Kit Juckes of Socit Gnrale expects a rate of $1.05 to the greenback. But there are plenty of factors that could bring the "Aussie party", as HSBC put it, to an end.