Currencies | Nov 04 2010
By Kathleen Brooks, research director UK, forex.com.
After the Reserve Bank of Australia slipped in an interest rate hike on the eve of the FOMC meeting, the Aussie dollar has made a brave attempt to breach parity with the US dollar. Whether or not it will settle comfortably above the 1.0000 mark will only be known in the coming days. So far it’s still finding immense resistance, and after hitting a high of 1.0025, subsequent attempts to push higher have failed at slightly lower rates. This suggests that there is a formidable technical barrier to one Australian dollar trading at a stronger rate than one greenback. But are there also fundamental reasons to worry about AUD/USD at parity?
Not according to RBA governor Glenn Stevens. In a statement after this week’s policy meeting, he made reference to a strong Aussie when he said that it will “assist, at the margin, in containing pressure on inflation.” Since one of the chief reasons for the rate hike was to ward off medium-term inflation pressures, it appears that the RBA is tolerant of a stronger currency. So the Aussie has cleared one of the hurdles to parity.
But for Aussie-US dollar to remain at or above parity will depend on whether or not a strong currency impacts the Australian economy and erodes its competitiveness. But there are two reasons Australia should be fairly immune to a stronger currency. Firstly, its export mix is very much in demand. Agricultural and mining exports account for 10 per cent of Australia’s GDP. Beef, milk and iron ore are just some of the commodities that Australian producers export to China (its largest export market) and other emerging market powerhouses that continue to grow strongly.
Secondly, on a trade weighted basis (the Aussie measured against its biggest trade partners) the rise in the Aussie since the start of the year doesn’t seem that dramatic. Currently it is up 6.6 per cent and remains below the peak reached back in April. This compares with the Japanese yen that has appreciated more than 15 per cent over the same time period.
It’s also worth bearing in mind that as long as Australia has the goods that fuels China’s economic expansion, then its exports should be fairly immune from Aussie dollar strength.
The largest part of the Australian economy is services, which makes up 68 per cent of GDP. This makes the Australian economy fairly resilient to a stronger Aussie. In fact, as a stronger Aussie boosts purchasing power parity for consumers, putting upward pressure on inflation, this causes the RBA to hike rates and can actually lead to more Aussie strength.
Another consideration is the global currency tensions and the upcoming G20 meeting. The world is concerned with currency devaluations, yet the Aussie is quietly appreciating. It is one of the strongest currencies in the G8 this year and has appreciated by nearly 12 per cent against the US dollar. This is backed up by strong fundamentals.
The Australian economy managed to avoid recession and is currently expanding at a healthy clip at 3.3 per cent on an annualised basis. Its budget deficit as a percentage of GDP is projected to be 2.3 per cent in 2011, much lower than other developed economies; currently the budget deficit in the UK is more than 11 per cent of GDP. Since Australia is in a healthier financial position compared with other developed economies, it figures that its exchange rate should be stronger. As long as the AUD keeps appreciating it is playing by the G20’s rules.
For now it looks like the fundamentals are in place for AUD/USD to reach parity. However, it’s a big psychological move for the market and may take a number of days or weeks before it can make the decisive break higher.
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