A resurgent Australian dollar could choke the early signs of recovery we are seeing in the business cycle.
The lowered currency was like a mini stimulus to the economy, easing some of the financial pressures businesses were feeling. Now with taper talk firmly off the Federal Reserve’s immediate agenda, the Australian dollar is climbing the stairway to parity once again.
If the Australian dollar becomes ensconced around mid-90 cents or higher it is going to have a suffocating effect on our economy. Ultimately our currency needs to be lower to help rebalancing an economy that is struggling to move on from a mining boom.
Exchange-rate sensitive areas of the economy - manufacturing, retail and tourism - each account for 10 per cent of Australia’s work force. The weaker dollar gave employees across this sector more certainty over their jobs and comfort to spend again, which has been confirmed in improving consumer confidence figures.
The benefits of a lower currency span across different sectors of the economy, assisting earnings for companies exposed to the US dollar and giving the job rate a lending hand.
Commodity producers thrive on a weaker currency. In 2007, BHPs average exchange rate was 79 cents. This added 26 per cent to BHPs bottom line for every dollar of iron ore sold. Six years later and it is a completely different story, especially when the dollar is above parity with the US dollar.
Manufacturers have seen a slow, structural decline accelerate as the Australian dollar strengthened. In the five years to March, the manufacturing sector lost a total of 140,300 jobs. A weaker currency was helping turn this sector around and helping companies to compete with Asian producers and their lower labour costs.
As domestic growth has trended well below average levels for much of this year, unemployment has slowly crept up. The softer currency had begun returning momentum to manufacturing, tourism and exporters. These sectors were starting to look investment-worthy in combination with a return to confidence and assurance over government policy.
But this will change quickly if the dollar holds on here or climbs further.
A temporary exchange rate closer to parity with the US dollar is manageable, but something more permanent does pose problems.
Profit recovery could stumble if the Aussie dollar remains this high. With the market considered to be fairly valued to possibly a touch overvalued at the moment, earnings need to strengthen to justify valuations. Otherwise, come reporting season in February, the market could be in for disappointment.
The Australian dollar trading at 95 cents is going to give the RBA headaches. Further rate cuts from here would certainly set a new wave of property-bubble warnings from experts.
On the other hand, raising rates would reignite international interest in our currency, and push it even higher.