Don’t expect the Aussie dollar to fall any further

A tsunami of currency depreciation is set to be unleashed across the region if Japanese policymakers respond to the recession by printing more money.

There’s been a lot of celebration about the weak Australian dollar recently -- especially from the tourism and education sectors. Unfortunately, much of it is extremely premature, because, just as these celebrations have ramped up, the local currency has pushed higher. Not on a USD basis perhaps, but certainly when measured against a basket of other currencies, on a trade weighted basis.

Key to that is the rapid appreciation of the Australian dollar against the yen and the euro, which together account for just under a quarter of the basket. The dollar is up over 9 per cent against the yen this year and 8 per cent against the euro. Otherwise, and against our other major trading partners, the Australian dollar has been steady.  

Under current circumstances, that stability would appear to be one of the best scenarios that we could hope for. There’s certainly not a lot on the horizon that points to a weakening currency. Indeed, news yesterday that Japan had entered another recession -- the fourth in about five years -- makes it extremely unlikely.

Have a think about how that kind of news is going to be greeted. With alarm I would imagine. Are the Japanese just going to sit idly by? No, cheered on by economic talking heads and bauble-wearing economists in the US and UK, Japan will probably print even more money. Maybe a round of fiscal stimulus will follow first, then it will print. That all its previous attempts have failed is clearly lost on Japanese policymakers. But then again, this is the genius of global economic policy making at the moment: If something doesn’t work, you just keep doing it, more aggressively and more ‘boldly’.  

Anyway, the broader issue is that Japan’s neighbours were already apprehensive about the weakening yen. In fact, only last week, South Korea’s central bank said that “if the yen falls further, it could become a concern” and that yen weakness was already putting pressure on South Korean exporters -- certainly Samsung is under pressure.

Knowing full well what the latest GDP numbers mean -- the Bank of Japan printing even more money -- the Koreans can only be a step away from slashing rates further. Indeed, the central bank already has the excuse it needs to cut, several times if needs be, with inflation well below target at around 1.2 per cent, and people expect them to. But then what?

Looking further around the region, Thailand’s exports are under pressure as well, its GDP is weak and inflation low. While the Thai central bank has yet to cut rates, it has left the door open and, naturally, it too would be watching Japan, South Korea and other major economies in the region very closely.

Taiwan for its part has wisely noted the absolute failure of Japan’s QE program and the failure of the weaker yen to really help the Japanese economy.  Taiwan has said that it doesn’t want to get into a futile currency competition with anyone. Yet here too inflation is tumbling and there really is only so much resistance a central bank can put up in the face of a sharply weaker yen -- and one that looks set to fall further.

It’s a political game that matters a great deal to Australia. The currencies of Malaysia, India, Indonesia and Taiwan make up another 14 per cent of our trade weighted basket.

That doesn’t leave us with much. The European central bank for its part, facing weak growth and inflation, is only a step away from providing more ‘stimulus’ to the eurozone via government bond purchases.  So the euro isn’t headed higher either -- and that’s another 9.5 per cent of the trade weighted index just there.

The bottom line?

I don’t think there are too many scenarios on the horizon where our currency weakens. Even the fall we’ve seen against the US dollar is likely only temporary, with few fundamental factors in support of a remaining below US90c for a sustained period. Just on the terms of trade, which remains historically high, and the yield advantage, the local currency should be closer to US95c.

Stranger things have happened I guess and there is a lot that has to settle, what with the US economy booming at the moment. We’ll see. We shouldn’t be under any illusions though.

The pressure on the Australian dollar to appreciate is strong. The question is, what, if anything, the RBA is going to do about it.

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