Inside Investor: The Australian dollar. Where to from here?

The Aussie dollar has dropped sharply in the past few months. Where could it go next?

During June and July, the local currency dived 12 per cent, driven lower by a combination of lower domestic interest rates and a soaring greenback as signs emerged that America’s economy was on the mend.

The catalyst was an off-the-cuff statement by Federal  Reserve chairman Ben Bernanke that he was preparing to wind back America’s massive monetary stimulus program, but only if and when the economy was healthy enough to do so.

Investors didn’t really take notice of the last bit – the qualification of “only if”.

As the Aussie dived, almost every analyst in town began forecasting a drop to US 85 cents,  with some even talking about US 80 cents.

They may be right in the long term, but there are a couple of factors that will limit the Aussie’s fall too far from here – between 90 cents and 95 cents – in the near future.

The main reason we are likely to see resistance to further sharp falls is that America cannot afford for the US currency to rise strongly.

As usual, the market overshot on the selling. While Bernanke set the selling in motion, he’s gone to extraordinary lengths since in an attempt to inject a bit of sense into the market.

That has seen the volatility that erupted during June and July settle, and the US dollar ease a little, which in turn will take the pressure off our currency.

The other factor that will weigh on the Australian dollar is China. Our biggest trading partner has begun to experience growing pains as its economy begins to mature.

Growth in China has begun to decelerate, although it is still expanding at a rate well above that of a developed economy. The International Monetary Fund recently cut its growth forecast for China to 7.8 per cent. The Chinese Government is forecasting growth of 7.5 per cent.

If its growth slows beyond expectations, or if commodity prices like iron ore fall sharply as they did during September last year, the Australian dollar will come under renewed pressure.

Barring that, the Aussie battler should stay above US 90 cents and may even go higher if the American dollar weakens.

Longer term though, the trend is set in stone. As America improves and as the resources investment boom wanes, the Australian dollar will head south.

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