Recovering Iron Ore Prices Help Australian Dollar Higher against the Pound

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The Pound-to-Australian Dollar exchange rate (GBP/AUD) has shifted lower in the wake of a recovery in iron ore prices, a development that tends to bode well for Australia's export earning potential.

The Australian Dollar's linkage to iron ore prices comes courtesy of the fact that the raw material is the country's largest export and foreign exchange earner, price dynamics in this market therefore have a strong impact on fluctuations in Australian Dollar value.

The below chart shows bulk iron ore prices in China (orange) - the majority of which arrives from Australia - against the Australian Dollar vs. Pound Sterling exchange rate (the inverse of the GBP/AUD):

As can be seen, the Australian Dollar rises against the Pound when iron ore prices are rising, but falls when the opposite is true.

For much of January the Australian Dollar fell against Sterling and other major currencies as iron ore prices fell, "iron ore prices also continue to constrain the upside in the AUD. Rising covid-19 infection rates in China as well as a seasonal slowdown in steel making are weighing on iron ore prices," said Valentin Marinov, Head of G10 FX Strategy at Crédit Agricole of the Australian Dollar's decline in January.

But the recent uptick seen over recent days has correlated with a rise in the Australian currencies value.

"Whether or not it can trend higher will still depend on risk sentiment, the USD and iron ore prices," says Marinov. "We continue to think that investors should pay attention infection rates in China as a potential barometer for the iron ore prices and the AUD."

We reported last Thursday that stabilising iron ore prices were starting to reflect in a firmer Aussie Dollar, and said further gains in the raw material would likely prompt further Aussie gains.

Although there were concerns of rising cases in January, data out of China over recent days suggests covid-19 outbreaks remain well contained and localised.

Regardless, iron ore prices have now put in five days of consecutive appreciation and indications suggest this is starting to reflect in a firmer Aussie Dollar and raises questions as to whether the GBP/AUD exchange rate recovery has peaked.

Improving market sentiment is meanwhile proving supportive of other commodity prices, such as copper and Liquified Natural Gas, which also account for a significant portion of the Australian export basket.

"Australia being a major commodities exporter, a pick up in industrial commodity prices like Copper & Iron ore has supported AUD flows. We expect further upside for Copper prices as we expect USD to soften and Chinese demand for commodities remains strong, suggesting further gains for AUD/USD," says Paul Robson, Head of G10 FX Strategy at NatWest Markets.

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