The Australian Dollar could be poised to benefit in the second quarter, appreciating from the spillover effects caused by Russia’s attack on Ukraine. This includes rising European demand for Australian exports, which could boost the latter’s economy and encourage a more hawkish policy stance from the Reserve Bank of Australia.

Moscow’s actions in Ukraine are driving Europe to speed up ending its reliance on Russian fossil fuels. Ursula von der Leyen, President of the European Commission, noted that the regional bloc will plan to do so by 2027. Despite a push for clean energy in recent years, the EU will likely need to find temporary relief from non-renewables. The common market has also banned imports of Russian steel.

This is where Australia comes into play. The country is the world’s largest exporter of iron ore and coal briquettes, as well as being the sixth biggest shipper of wheat. According to Reuters, coal producers have been ‘bombarded’ with supply calls from European countries. It might be difficult for Australian miners to quickly ramp up production and adjust shipping destinations, helping commodity prices to remain elevated.

Might this offer a boost to Australia’s economy? According to data from Bloomberg, real GDP is expected to increase 4.4% y/y in 2022, down from 4.8% in 2021. The Reserve Bank of Australia has acknowledged numerous uncertainties. Governor Philip Lowe mentioned in March that the central bank is assessing how persistent supply-side problems will be.

One thing is for sure: markets have been ramping up RBA rate hike expectations. Towards the end of March, overnight index swaps were pricing in six 25bps increases from the central bank. On the chart below, this can be seen reflected in rising Australian 10-year government bond yields since the war in Ukraine broke out. Note the parallel rise in the majors-based Australian Dollar index.

Australian Dollar Fundamental Drivers – Commodities, RBA Monetary Policy

Australian Dollar May Rise as Europe Seeks Alternatives: Top Trade Opportunities

Chart Created in TradingView

*Majors-Based Australian Dollar Index averages AUD against USD, EUR, GBP and JPY

Meanwhile, iron ore futures and the stock price of key Australian mining co. Whitehaven Coal stock also climbed. In all, the fundamental landscape may be setting up to continue offering support to the Aussie. The Euro and British Pound may be particularly vulnerable considering their proximity to the Eastern Europe crisis. Tellingly, EUR/AUD and GBP/AUD have tumbled since the attack on Ukraine began.

It should be noted that the Australian Dollar can at times function as a sentiment-linked currency, following global stock markets. This is due to Australia finding itself at the front-end of the global supply chain. As such, deteriorating global growth estimates may work against AUD. Still, elevated commodity prices, and rising European demand for Australian goods, may cushion against this risk.

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