41858 – The Exchange Rate and the Open Economy | Australian Property Network™

41858 — The Exchange Rate and the Open Economy

Overview

The exchange rate is the price of the Australian dollar in terms of another currency, and it is the price through which everything that happens in the rest of the world reaches Australia. Since December 1983 that price has been set in the market: as the RBA puts it, movements in the dollar “are determined by the demand for, and supply of, Australian dollars in the foreign exchange market”.¹ The result is one of the more volatile currencies among developed economies. Against the US dollar it has traded as low as 49 cents and as high as $1.10 since the float, and each swing has changed the price of imports, the returns to exporters, the cost of building materials, and the attractiveness of Australian assets to foreign buyers.^1,6

This entry explains how the exchange rate is measured, what moves it, why Australia’s terms of trade sit at the centre of the story, and what the record since 1969 shows. It closes on the exchange rate’s specific channels into property: import prices, foreign demand, and the way a floating currency absorbs shocks that would otherwise land on interest rates.^3,4

Scope & Boundaries

This entry covers:

Bilateral exchange rates and the trade-weighted index
The fixed and managed regimes before 1983, and the float
What drives the dollar: interest rate differentials, the terms of trade, and risk
The record since 1969 against the US dollar and the basket, and the terms of trade since 1959
How the exchange rate reaches prices, activity, and property

This entry does not cover:

How the cash rate is set — addressed in 41851
The pass-through of a lower dollar into consumer prices — addressed in 41852
GDP, real income, and the composition of growth — addressed in 41855

Scope Note

This entry is educational background within an editorial essay series. Its charts use the Reserve Bank of Australia’s published exchange rate statistics and the Australian Bureau of Statistics national accounts, cited in full at the end of the page. APN’s certified readings of Australian economic conditions are maintained separately in the 21200 series.

Key Concepts

Bilateral rates and the trade-weighted index

A bilateral exchange rate is the price of one currency in another: the Australian dollar against the US dollar (AUD/USD) is the most quoted, and it is the one used for commodity contracts, most foreign borrowing, and most headlines. But the US dollar is one trading partner among many, and a fall against it may be a rise against the yen or the yuan. The RBA therefore publishes a trade-weighted index (TWI), which “captures the price of a domestic currency in terms of a weighted average of a group or ‘basket’ of currencies”, weighted by each partner’s share of Australia’s trade and rebased so that May 1970 equals 100.² The TWI is the better measure of the dollar’s overall level; the US dollar rate is the better measure of the price Australia receives for iron ore, coal, and gas.

From fixed to floating

For most of the twentieth century the Australian pound and then the dollar were pegged, first to sterling, from 1971 to the US dollar, and from 1974 to a basket, with the peg adjusted by government decision: revalued upward three times in 1972–73, devalued in September 1974 and again by 17.5 per cent in November 1976, then crawled against the basket from 1976. On 12 December 1983 the dollar was floated and exchange controls were abolished.^1,2 Under a float, the RBA “intervenes to affect the level of the exchange rate only on rare occasions if market conditions are disorderly”; it did so in the 2008 crisis, and its stated grounds today are a market that “becomes disorderly or dysfunctional” or a currency “grossly misaligned from a value implied by Australia’s economic fundamentals”.^1,2 A floating rate is more volatile than a peg, but it is also a shock absorber, and the RBA credits it with much of the reason the end of the mining boom was “much less disruptive” than earlier commodity busts.⁴

Chart 1

Australian dollar against the US dollar, July 1969 to August 2026 (US$ per A$, end-month)

Source: RBA Statistical Table F11, Exchange Rates — Monthly, end-month observations. Pegged to the US dollar until 1974 and managed against a basket until the float on 12 December 1983; market-determined since.

The record against the US dollar

In 1969 one Australian dollar bought US$1.11. The revaluations of 1972–73 took it to US$1.49 by the end of 1973, the highest level in the series, and the devaluations of 1974 and 1976 brought it back to parity. On the eve of the float in December 1983 it stood at 90 cents. The 1985–86 fall, when the terms of trade fell to their lowest level in the series and the Treasurer of the day warned of a “banana republic”, took it to 60 cents. It spent the 1990s in the 60s and 70s, then fell through the technology boom and the Asian crisis aftermath to its post-float low, 49 cents at the end of March 2001. The mining boom reversed all of that: the dollar reached parity in late 2010 and its post-float high, US$1.10 at the end of July 2011.⁶ It has not been above parity since April 2013. The fall from 2011 to 2015 was steady; the 2008 crisis was not, with the dollar losing a third of its value in five months, from 96 cents in June to 66 cents in November. The pandemic low was 62 cents in March 2020. At the end of August 2026 the dollar bought 71.7 US cents, close to its post-float average of 75 cents.^6,8

Chart 2

Trade-weighted index, May 1970 to August 2026 (May 1970 = 100, end-month)

Source: RBA Statistical Table F11, trade-weighted index of the Australian dollar, end-month observations. The index is a weighted average of the dollar against the currencies of Australia’s major trading partners.

The record against the basket

The trade-weighted index tells a longer and, in one respect, starker story. It peaked at 121 in January 1974 and has never returned to its starting level of 100. It was 81 at the float, 47 at its low in September 2001, 79 at the top of the mining boom in February 2012, and 66 at the end of August 2026, a little above its post-float average of 62.⁶ Two features of the TWI stand out. First, the fall since the 1970s is largely a fall against the currencies of Asian trading partners that industrialised, and against a German mark and then a euro that appreciated over decades; it is not primarily a US dollar story. Second, the swings since the float are smaller in the TWI than against the US dollar alone, because when the US dollar strengthens against everything, the Australian dollar’s fall against it is partly offset by its stability against other currencies. The RBA’s own summary of the post-boom adjustment makes the distinction: by 2017 the dollar was “around 30 per cent lower” against the US dollar than at its 2011 peak, but only “about 16 per cent lower” against the basket.⁴

Chart 3

Terms of trade, 1959 Q3 to 2026 Q2 (index, seasonally adjusted)

Source: ABS Australian National Accounts, Table 1, terms of trade index, seasonally adjusted. The ratio of export prices to import prices; the reference year is set to 100 by the ABS.

The terms of trade

The RBA’s explainer defines it in one sentence: “The terms of trade measures the ratio of export prices to import prices.” When the price of what Australia sells rises relative to the price of what it buys, the same volume of exports pays for more imports, national income rises faster than national output, and, in the RBA’s words, “an increase in the terms of trade is associated with an appreciation of the Australian dollar”.¹ Because commodities are most of what Australia exports, the terms of trade are largely a commodity price index. The series has three defining episodes. The long decline from the 1950s wool boom to the trough of December 1986, when the index stood at 44, its lowest reading; the mining boom, in which the index rose from 54 in mid-2003 to 105 in September 2011, almost doubling, and which the RBA calculates put the terms of trade “around 75 per cent above the average of the preceding century”; and the 2021–22 energy shock, when the index reached 116 in the June quarter of 2022, the highest reading in the series, before falling back to 95 by mid-2026.^4,7

Chart 4

The dollar and the terms of trade, 1984 Q1 to 2026 Q2

Source: RBA Statistical Table F11 (quarter-end A$/US$, left axis) and ABS Australian National Accounts, Table 1, terms of trade index (right axis). The two series have moved together through every major cycle since the float.

What moves the dollar

The RBA distinguishes drivers by horizon.¹ Over years, the terms of trade dominate, and Chart 4 shows the relationship: every large move in commodity prices since the float has been matched by a move in the currency in the same direction. Over months, “the interest rate differential is a key driver of the demand for, and supply of, Australian dollars”: when Australian rates are high relative to those abroad, foreign investors buy Australian dollars to earn them, and when the differential narrows, they sell.¹ Over days, the dollar trades as a barometer of global risk appetite, falling when investors retreat to the US dollar, which is why it fell so hard in late 2008 and in March 2020 even though nothing specific to Australia had changed. In the very long run, the RBA notes, purchasing power parity says exchange rates “should settle at a level that makes goods and services cost the same amount in both countries, although it is difficult to see this in the historical data”.²

How the exchange rate reaches the economy

The RBA’s explainer works through a depreciation.³ A lower dollar makes Australian exports cheaper abroad and imports dearer at home, so demand shifts toward Australian production: exporters, tourism operators, and universities gain, and import-competing firms gain. It also raises the Australian-dollar price of imported goods, which lifts inflation directly and, if the depreciation is large, feeds into wages and other prices. An appreciation does the reverse, squeezing the non-mining tradeable economy while holding prices down; the RBA describes the high dollar of 2011–13 as having its most obvious effects “in the non-mining sectors of the economy, such as the tourism industry”, which were not sharing in the commodity windfall.⁴ The shock-absorber property follows: when commodity prices fall, the dollar falls with them, and the fall in the dollar offsets part of the loss of income by making the rest of the economy more competitive, which is a large part of why the end of the mining boom did not produce a recession.⁴

Regulatory & Legal Framework

The Australian dollar has floated since 12 December 1983, when the government of the day removed the managed peg and the exchange controls that had accompanied it. The RBA’s responsibility for the currency derives from the Reserve Bank Act 1959, under which it manages Australia’s foreign reserves and may operate in the foreign exchange market; its stated practice is to intervene only in a disorderly or dysfunctional market or against gross misalignment, and it notes that intervention “has become less” frequent as the market has matured.^1,5 The Bank publishes the exchange rate daily at 4 pm Sydney time, together with the trade-weighted index, and maintains the monthly history from 1969 used in this entry.^5,6

The exchange rate is not a policy target. The RBA’s mandate is price stability and full employment, and the currency enters its decisions as a determinant of both, through import prices and through the competitiveness of the tradeable sector; the Bank does not set the cash rate to move the dollar, but it takes the dollar’s level into account when it sets the cash rate.^1,3 Foreign purchases of Australian residential property, one of the channels through which the exchange rate reaches the housing market, are regulated separately under the foreign investment framework administered by the Treasury, which restricts non-residents largely to new dwellings.

Practical Application

Construction costs. A substantial share of the materials, fittings, and equipment in a new dwelling is imported or priced against imports: steel, appliances, glass, solar panels, lifts, and much of the electrical and plumbing fit-out. A 10 per cent depreciation raises the Australian-dollar cost of those items by roughly 10 per cent over the following year or two, with the effect arriving after the currency has moved, not with it. The fall in the dollar through 2022, from 75 US cents in March to 64 in October, was one of the contributors to the surge in new-dwelling costs described in 41852.

Foreign demand and relative value. To a buyer whose wealth is held in US dollars, Australian property became about a third cheaper between mid-2011 and late 2015 with no change in local prices at all, and about a quarter dearer between March 2020 and February 2021. The exchange rate is the largest single term in the foreign buyer’s calculation, larger than any change in local prices over a similar horizon, and it also determines the Australian-dollar value of the income that migrants and returning expatriates bring with them.

The dollar as a signal. Because the currency moves with the terms of trade, a sustained fall in the dollar is usually a sign that national income is falling relative to output, which reaches property through state royalties, resource-region employment, and, with a lag, wages. A sustained rise usually accompanies a commodity boom and, as in 2010–12, a higher cash rate. Reading the dollar together with the terms of trade in Chart 4, rather than alone, is the way to tell a commodity story from a risk-appetite story, and the two have very different implications for interest rates.^1,4

Cross-Series References

41851

Interest Rates: The Price of Money

The interest rate differential that moves the dollar from month to month, and the cash rate behind it.

41852

Inflation: Why Prices Rise

How a lower dollar feeds into the prices of imported goods, and how much of it reaches the CPI.

41855

Economic Growth and GDP

Real GDP versus real income: why the terms of trade make the two diverge in a commodity economy.

21200

Economic Factors

APN’s certified readings across the economic indicators, updated as each release lands.

Sources

1. The Drivers of the Australian Dollar Exchange Rate — Reserve Bank of Australia, Explainer
2. Exchange Rates and their Measurement — Reserve Bank of Australia, Explainer
3. Exchange Rates and the Australian Economy — Reserve Bank of Australia, Explainer
4. Australia and the Global Economy — The Terms of Trade Boom — Reserve Bank of Australia, Explainer
5. Exchange Rates — Reserve Bank of Australia, Statistics
6. Statistical Table F11, Exchange Rates — Monthly, January 2010 to current — Reserve Bank of Australia
7. Australian National Accounts, Table 1, Key National Accounts Aggregates (terms of trade index) — Australian Bureau of Statistics
8. Statistical Table F11, Exchange Rates — Monthly, July 1969 to December 2009 (history file) — Reserve Bank of Australia

This entry is part of the Understanding Money editorial essay series and is presented for general educational context. APN’s certified readings of Australian economic conditions are maintained in the 21200 Economic Factors series.

41858 – The Exchange Rate and the Open Economy