A lesser lustre for the Australian dollar

Re-emergence of market risk, rate cut expectations and soft commodity prices have undercut support for the Australian dollar, but it should remain at levels that are still historically high.

Apart from the fact that it was a silly idea anyway, Paul Howes’ plea for changes to the Reserve Bank’s charter to allow it to try to actively influence the value of the Australian dollar was poorly timed, given that the dollar is now trading at its lowest levels in three months and about 7.5 cents below last year’s peak.

That could, of course, change. Part of the explanation for the sharp fall in the dollar against the US dollar over the past three weeks in particular is the renewed anxiety about the stability of the eurozone, a nervousness that has increased sharply in the past week as fresh doubts about the ability of Spain and Italy to implement their tough fiscal programs surfaced.

While the eurozone and US – awash with the liquidity pumped out by their central banks risk assets – and the US sharemarket in particular had been on something of a run over the past three months, it appeared that the European Ponzi trick of the European Central Bank lending € 1 trillion of cheap three-year money to southern European banks so that they could buy their countries’ sovereign debt to keep bond yields down had worked.

The ECB interventions, however, weren’t solutions to the eurozone’s problems but simply bought some breathing space and, it transpires, a false sense of optimism that the worst of the eurozone crisis was over – which took some of the pressure off the politicians charged with implementing austerity programs.

All through last year it was obvious that whenever the risks of an imminent implosion in Europe receded the Australian dollar – and its Canadian counterpart – rose as all the cheap liquidity parked around the globe was deployed into ‘riskier’ assets. Conversely, at the first hint of bad news in Europe, or the US, those funds flooded out of risk assets and back into the perceived safe havens of US Treasuries and gold.

The combination of the fresh wobbles in Europe and last week’s weak US employment numbers mean that this is very much a ‘risk on’ environment and therefore the speculative support for the Australian dollar – attractive by the high real returns in the bond market – isn’t there.

There is, of course, another reason for the dollar’s weakness and one that could keep a lid on its value for some time.

Our terms of trade have peaked, at least for the moment, with commodity prices down across the board, driven by the deliberate slowing in China’s growth rate and the maturation of the infrastructure phase of its development.

China is now targeting growth of 7.5 per cent this year, which would be its lowest rate of growth in eight years, and there are some concerns that it might undershoot even that target. With both the European and US economies still stalling and the Chinese deliberately slowing their domestic activity it isn’t surprising that China’s growth rate has tapered (On the cusp of a China rebalancing, April 11).

If commodity prices don’t surge again, and the eurozone remains a threat to global stability and growth – as one would expect it to be for some years even if the potential implosions of the too-big-to-fail/too-big-to-rescue southern European economies are avoided – it would difficult to imagine the Australian dollar climbing back towards the $US1.10 level unless for some reason there was an historic loss of confidence in the US dollar.

With the Reserve Bank signalling last week that it is inclined, the March quarter CPI outcome permitting, to cut official rates again next month, there is another reason for our dollar to be a little weaker.

It should, however, remain at levels that are still historically high because, while China’s growth rate has slowed it is still solid growth over a vastly larger economic base than it had before it ignited the resources boom and resource companies are still scrambling to expand their output to supply that growth.

That is having, and will continue to have, a significant adverse impact on manufacturing industry and tourism. There is a major restructuring of the non-resource side of the economy occurring, with considerable job losses. A highly contractionary budget, combined with the looming introduction of the carbon tax, isn’t going to help.

A significant further weakening in the value of the dollar – a return to its pre-boom levels – however, while highly unlikely, might be an even worse outcome as it would probably signal that the resources boom was over and that the hundreds of billions of dollars being invested in expanding the sector’s capacity had been wasted.

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