The fluctuating relative strength of the Aussie dollar is yet another reflection of major economies feeling the strain of cost of living pressures, rising interest rates and inflation. 

With the Australian dollar withdrawing from a six-week high in late July, now hovering below the US$0.65 mark and the RBA hiking interest rates to 2.85%, each piece of global and Australian economic data is being heavily scrutinised to see how currency markets will respond. 

Currency market volatility impacts the cost of doing business globally. 

More than ever, SMEs are taking action to minimise the negative impacts of rising interest rates and currency fluctuations on their bottom line.

Explaining the relationship between interest rates, inflation and foreign exchange (FX)

Let’s first break down how interest rates, inflation and FX are interrelated to give you a working knowledge of how this could impact your business’s cash flow.

To start, central banks can impact spending and the cost of goods and services by increasing and decreasing interest rates. Consecutive rate rises, as Australia has been experiencing, increase the cost of borrowing for businesses which is then passed on to consumers. This tends to make it more expensive for businesses to invest and make consumers less confident about discretionary spending, both of which add pressure for SMEs trading globally.

As interest rates go up, investors tend to buy holdings in the currency where the interest yield is higher, and the increase in demand sees the currency gain in value. Conversely, as investors sell off lower-yielding currencies, the drop in demand decreases currency value.

In essence, a weaker Australian dollar means local businesses, such as Australian-based automotive and clothing retailers, will pay more for international products and services.

However, Australian companies that earn revenue in overseas currencies while incurring expenses in Australian dollars, are better placed to benefit from local products and services becoming more globally competitive.

Managing risk in inflation-driven volatile currency markets

Predicting currency rates is nearly impossible, but SMEs can use the below tools to help manage FX risk when moving money globally:

Limit Order: this enables you to nominate a target rate for an amount of currency in the hope that the rate will be reached within a specific time frame. If the rate is reached, the currency is purchased for you automatically.

Forward Contracts: this provides the ability to secure an exchange rate based on today’s rate for a future-dated transfer up to twelve months in advance.

Both tools can help offset currency exposure risk, create potential cash flow buffers, and offer more currency certainty. In turn, this can facilitate better pricing conditions so businesses can avoid passing on costs to consumers.

It’s also possible to protect against currency swings through natural hedging, where overseas earnings and costs are managed in the same currency. This removes the barrier of having to convert revenue at exchange rates you can’t control. Some FX payment providers offer multi-currency accounts to create this natural hedge; the OFX Global Currency Account for example, enables businesses to open up to nine virtual currency accounts to make and receive payments.

Every small business trading internationally should have a currency risk management plan. If you’re uncertain about the best solution for your business, get in touch with an FX specialist; their knowledge of global market movements and FX cost planning could help your business.

Other Australian businesses’ reactions to inflation

For a number of years, the influence of inflation has been largely absent from the macro-economic picture, but no longer; the full force of inflationary impacts are certainly being felt.

Inflationary pressure on interest rates and currency exchange rates could mean SMEs with their eyes on expanding overseas become more cautious. 

However, it’s encouraging to observe organisations taking a proactive approach to currency risk planning. OFX data for September showed a month-on-month increase in both Limit Orders and Forward Contracts from its Corporate books as businesses sought more cash flow certainty and control.

This increased activity could be attributed to exporters who favour a weaker AUD seeking to lock in their position, or Australian organisations with offshore ties who may be concerned the AUD will slide lower wanting to protect their margins. In both cases, currency risk tools can give businesses greater certainty in a volatile currency environment.

Get ahead, stay ahead

With the looming threat of a global recession, interest rate hikes will continue to be a driving economic force that currency markets could react to.

For SMEs to thrive in the tough economic conditions expected ahead, understanding the role of FX in the economic puzzle and adjusting business finances accordingly could mean the difference between competitive growth and leaking hard-earned profit. I encourage all businesses to arm themselves with the necessary FX tools and resources to prepare for ongoing currency volatility.

Content provided by Michael Judge, Head of Australia and New Zealand, OFX