The Reserve Bank of Australia (RBA) sets interest rates and manages monetary policy for Australia. Decisions are made by a Board of Governors at 11 meetings per year and ad hoc emergency meetings as needed. The RBA’s primary mandate is to maintain price stability, which means an inflation rate of 2-3%, but also to “contribute to currency stability, full employment and the economic prosperity and well-being of the Australian people.” Its main tool for achieving this goal is raising or lowering interest rates. Relatively high interest rates strengthen the Australian dollar (AUD) and vice versa. Other tools used by the RBA include quantitative easing and tightening.

While inflation has traditionally always been seen as a negative factor for currencies as it lowers the value of money in general, in modern times with the loosening of cross-border capital controls the opposite is actually true. Moderately higher inflation now tends to lead to central banks raising their interest rates, which in turn tends to attract more capital inflows from global investors looking for a lucrative investment opportunity for their money. This increases the demand for the local currency, in Australia’s case that is the Australian dollar.

Macroeconomic data measures the health of an economy and can affect the value of its currency. Investors prefer to invest their capital in safe and growing economies rather than precarious and shrinking ones. Larger capital inflows increase aggregate demand and the value of the country’s currency. Classic indicators such as GDP, purchasing managers’ indices for manufacturing and services, employment and consumer sentiment surveys can influence the AUD. A strong economy can prompt the Reserve Bank of Australia to raise interest rates, which also supports the AUD.

Quantitative easing (QE) is a tool used in extreme situations when lowering interest rates is not enough to restore credit flow in the economy. QE is the process by which the Reserve Bank of Australia (RBA) prints Australian dollars (AUD) to buy assets – usually government or corporate bonds – from financial institutions, providing them with much-needed liquidity. QE usually results in a weaker AUD.

Quantitative tightening (QT) is the opposite of QE. It is carried out after QE, when an economic recovery is underway and inflation begins to rise. While in QE the Reserve Bank of Australia (RBA) buys government and corporate bonds from financial institutions to provide them with liquidity, in QT the RBA stops buying more assets and stops investing the maturing principal of the bonds it already holds. This would be positive (or bullish) for the Australian dollar.