01 Aug THE GREAT AUSSIE DOLLAR YO YO

What’s in store for the Aussie dollar over the coming months?  Interest rates are set to head downwards as the dollars weakens against it’s US counterpart.  But what are the implications for Australian businesses and the health of the economy?

You can read Andrew’s analysis of what’s ahead for the Australian dollar below or click on the link at the bottom of the page for a PDF version.  We’d love to hear any comments you’d like to share with us.

 Can you “Walk the Dog” and predict the Australian dollar?

Last weeks’ article mentioned how difficult it is to forecast interest rate movements. This week we look at the recent performance of the Australian dollar, discuss how it’s movements are important to business, identify it’s drivers and where it might go from here.

Why do Aussie dollar movements matter to businesses?

• First, for those industries that export there can be huge swings in the prices charged for your goods abroad, eroding your price competitiveness compared to other foreign businesses.
• A weakening exchange rate imports inflation by increasing prices in the supply chain (raw materials, energy etc.). It can therefore leave you with a choice to either absorb the cost increases and have lower profit margins, or risk passing it on to your customers threatening demand.

What has driven recent movements in the Australian dollar?

From early 2009 until 2012 the dollar has been on a rapid strengthening streak. In this period the dollar rose from around a monthly average of US$0.63 to a high of US$1.10 (see graph below), and this mirrored strength against the UK Pound and the Euro. The main drivers of Aussie were:

1. US dollar, Euro and UK weakness and monetary easing including  Quantitative Easing (Q.E.)
2. Mining boom and high commodity prices driving overall economic growth.
3. Australia’s AAA rating and perceived safe harbour status as international investors waded in.
4. High Australian interest rates resulting in large rate differentials and carry trade support.
5. Direct government intervention.

The combination of all these factors resulted in the perfect strengthening storm for the Aussie (yellow zone above). The green zone is the boosted zone from US$0.80 to US$1.00 where the dollar has performed from 2007 except during the GFC volatility. The orange zone (US$0.60-US$0.80) is where the dollar traded from 2003 to 2007 and is close to the long term average performance normal around US$0.78. The red zone is the extreme weak zone witnessed from 2000-2003.

What is ahead and why?

In recent weeks though the dollar has weakened toward US$0.90 mostly as markets bet that the US economy was gaining some momentum and quantitative easing was coming to an end.  As the other engines of recent Aussie dollar strength also erode in the year ahead, we can expect a further weakening of the dollar. We also know from past economic history that currencies are more likely to undershoot long term performance (maybe US$0.65) before reverting to mean (US$0.80).

Implications for business

We are an importing and consuming nation.  Be prepared for more pressures from the cost side of your balance sheet as the exchange rate weakens.  Prepare for that now by looking carefully at other non-sensitive exchange rates costs, including wage, energy and financing costs.  Best being prepared than being caught in the Gravity Pull, the Creeper or the Round the World by the Yo Yo!

Andrew Stockman

Economist