Australian Dollar strengthens as US-EU standoff dents the Greenback

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The Australian Dollar (AUD) edges higher against the US Dollar (USD) on Tuesday, as investors trim exposure to the Greenback amid rising tensions between the United States and the European Union (EU). At the time of writing, AUD/USD trades around 0.6744, extending gains for a second straight day.

The Australian Dollar extends gains as trade war fears pressure the Greenback.
European leaders warn of retaliation after Trump’s tariff threat.
China’s upbeat GDP data and RBA rate hike speculation provide additional tailwinds.

The US Dollar is being undermined by renewed 'Sell America' sentiment after US President Donald Trump threatened fresh tariffs on eight European countries as part of his latest push to secure control of Greenland.

European leaders have pushed back strongly against the tariff threat, warning that retaliatory measures could be taken. The escalation has revived fears of a broader trade war and raised the risk that the European Union could suspend the EU-US trade deal agreed last year.

Earlier on Tuesday, US officials doubled down on the administration’s trade stance. US Trade Representative Jamieson Greer said President Trump’s Greenland-related tariff threat is an “appropriate use of tariffs,” adding that the European Union has “done nothing” to implement the US-EU trade deal. Meanwhile, US Commerce Secretary Howard Lutnick warned that if Europe retaliates, the United States would respond, saying it would become a “tit-for-tat” situation.

However, the legality of President Trump’s tariffs remains uncertain. The US Supreme Court declined to rule on the measures on Tuesday, suggesting that the legal challenge to his trade policy could take at least another month to resolve. With the court entering a four-week recess, the next possible ruling date is February 20.

Meanwhile, Chinese data has offered an additional tailwind for the Aussie, given Australia’s heavy trade reliance on China. On Tuesday, the People’s Bank of China left its benchmark interest rate unchanged at 3%. Earlier, data released on Monday showed China’s economy grew by 1.2% QoQ in the fourth quarter, beating expectations of 1%, while annual Gross Domestic Product (GDP) rose 4.5% YoY above forecasts of 4.4%.

On the monetary policy front, speculation is building that the Reserve Bank of Australia’s (RBA) next move could be a rate hike at its February meeting. Attention now turns to Australia’s employment data due Thursday, which could influence near-term expectations.

In the United States, the Federal Reserve (Fed) is widely expected to keep interest rates unchanged at its January 27-28 meeting, though markets continue to price in two rate cuts later this year.

Traders are now looking ahead to upcoming US data, including the Personal Consumption Expenditures (PCE) inflation report and the advance estimate of third-quarter annualized GDP due on Thursday.

RBA FAQs

What is the Reserve Bank of Australia and how does it influence the Australian Dollar?

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 a year and ad hoc emergency meetings as required. The RBA’s primary mandate is to maintain price stability, which means an inflation rate of 2-3%, but also “..to contribute to the stability of the currency, full employment, and the economic prosperity and welfare of the Australian people.” Its main tool for achieving this is by raising or lowering interest rates. Relatively high interest rates will strengthen the Australian Dollar (AUD) and vice versa. Other RBA tools include quantitative easing and tightening.

How does inflation data impact the value of the Australian Dollar?

While inflation had always traditionally been thought of as a negative factor for currencies since it lowers the value of money in general, the opposite has actually been the case in modern times with the relaxation of cross-border capital controls. Moderately higher inflation now tends to lead central banks to put up their interest rates, which in turn has the effect of attracting more capital inflows from global investors seeking a lucrative place to keep their money. This increases demand for the local currency, which in the case of Australia is the Aussie Dollar.

How does economic data influence the value of the Australian Dollar?

Macroeconomic data gauges the health of an economy and can have an impact on the value of its currency. Investors prefer to invest their capital in economies that are safe and growing rather than precarious and shrinking. Greater capital inflows increase the aggregate demand and value of the domestic currency. Classic indicators, such as GDP, Manufacturing and Services PMIs, employment, and consumer sentiment surveys can influence AUD. A strong economy may encourage the Reserve Bank of Australia to put up interest rates, also supporting AUD.

What is Quantitative Easing (QE) and how does it affect the Australian Dollar?

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

What is Quantitative tightening (QT) and how does it affect the Australian Dollar?

Quantitative tightening (QT) is the reverse of QE. It is undertaken after QE when an economic recovery is underway and inflation starts rising. Whilst in QE the Reserve Bank of Australia (RBA) purchases government and corporate bonds from financial institutions to provide them with liquidity, in QT the RBA stops buying more assets, and stops reinvesting the principal maturing on the bonds it already holds. It would be positive (or bullish) for the Australian Dollar.

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