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As Australia’s central bank chief Philip Lowe jets off to Jackson Hole to discuss a global economy increasingly buffeted by presidential tweets, he’ll want to have his messaging right to avoid upsetting one of the few metrics that are moving his way.
The Australian dollar has dropped almost 17% since early last year, reaffirming its role as a key economic shield from shocks that have ranged from the 1997-98 Asian financial crisis to the 2008 global meltdown. Yet with Donald Trump urging the Federal Reserve to slash interest rates and weaken the greenback, that traditional cushion could be at risk.
“When global economic growth slows and when U.S.‑China trade tensions escalate, the U.S. dollar typically strengthens,” said Richard Grace, chief currency and rates strategist at Commonwealth Bank of Australia in Sydney. The Aussie would likely fall further if not for expectations of the Fed cutting another 75 basis points by mid-2020, narrowing the Australia-U.S. rate gap “and generating some extra support for global economic growth.”
Australia has shown itself an early mover in the global easing cycle -- cutting rates in June and July to a record-low 1% -- in what is looking increasingly like a race to the bottom. Those reductions helped push the Aussie dollar to a 10-year low, lifting the competitiveness of exporters and import-competing industries at a time when the economy has decelerated sharply.
Lowe will need to choose his words wisely when he speaks on a panel at Jackson Hole this weekend. The Reserve Bank is forecast to cut twice more by the end of the first quarter, but the governor has signaled he’s on hold for now as he waits to see how the back-to-back cuts play out. Any suggestion from him of a longer pause could spark a jump in the Aussie come Monday.
The RBA, in minutes of its Aug. 6 policy meeting, spent some time discussing global currency markets, highlighting their increased volatility in response to the U.S.-China economic confrontation.
“In particular, the yen had appreciated against the U.S. dollar while the Chinese yuan had depreciated,” the RBA said Tuesday. “Members took note of the market commentary that the U.S. and Japanese authorities could intervene in an effort to lower the value of their currencies.”
If major banks did try to depreciate their currencies, the Aussie dollar would probably rise in response. In the meantime, it is finding a degree of support from a dramatic improvement in the current account, which could record its first surplus since 1975 in data due Sept. 3.
Commonwealth reckons that in the next couple of years, the current account will average a deficit of just 0.2% of GDP, compared with 4.2% over the past three decades.
“The structural improvement in Australia’s current account deficit is a major supporting valuation factor for the Australian dollar,” Grace said. “The net income deficit has narrowed because low interest rates have reduced Australia’s foreign debt repayments and because increased offshore equity investment has resulted in net dividend income inflows.”
A spike in the price of iron ore, Australia’s biggest export, has also brought a huge windfall on the trade side. Still, the second quarter could prove a peak as Brazil’s supply problems are resolved and Chinese mills scale back output, with iron ore futures falling through $80 after having hit $120 around mid-year.
With the RBA’s cash rate forecast to fall to 0.5%, the scope for local banks to pass on any further easing will be crimped unless Lowe opts for unconventional measures. Either way, the currency is likely to prove an ever more important monetary policy channel for the RBA in the period ahead.
If the past is any guide, the Aussie will keep falling and pull the economy through, allowing Australia to extend its 28-year run without recession.
--With assistance from Garfield Reynolds.
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