"The only part, from what I know, which has actually something to do with bonds is the change from an expected fall in interest rates and the actual fall.
In Europe, As people expect IR to fall people change to bonds (bond prices rise with lower IR) which then causes IR to fall. Expectations become reality.
Then the relative interest rate differential improves for Australia, attracting funds to Australia and reducing Australian's movement of funds overseas.
This is what I believe is correct."
This is, in part, correct.
1. In Europe, people expect interest rates to fall. This increases the demand for Euro bonds from capital gains seekers and the demand for money falls. Because it was a NON INTEREST RATE change in money demand, it causes a fall in autonomous money demand.
2. This causes actual interest rates to fall in Europe (self fulfilling prophecy).
3. Australia's real interest rate improves relative to Europes, therefore increasing the demand for the Australian dollar and decreasing the supply of the Australian dollar.
which would result in the exact opposite conclusion of my original argument.
I think that it would be quite possible to get full marks using this argument at the 1st year level of analysis. But the above argument ignores what happens to the demand and supply of Australian dollars BEFORE our real interest rate improves relative to Europes.
It would probably take up too much time to do a proper analysis in 35 minutes, so yeah, I'm probably going to write what dwh argues, even though it is flawed.
