Australia | Aug 11 2008
By Chris Shaw
Having previously predicted the Australian dollar would reach parity against its US counterpart sometime in the next 12 months, Westpac Banking Corporation has now revised its view to account for a wave of bad news for the currency in recent weeks. News that has caused it to fall by 9c in the past three weeks or so.
Parity, at least on a 12-month view, now seems unlikely in the view of the bank’s chief economist Bill Evans, particularly as there has been a swing in recent weeks by professional investors out of commodities and resource stocks and back into financials and the US dollar. This switch was helped both by signs US financial institutions will be supported by authorities and renewed concerns the Chinese economy is slowing, putting the resources “Supercycle” under question.
This change in outlook for commodity prices accounts for about 40% of the Aussie dollar’s recent decline in Evans’ view, the other 60% being the result of specific local issues, the most significant being the change in monetary policy hinted at by the Reserve Bank of Australia (RBA).
Until recently, Evans points out many in the market had been factoring in two further rate hikes before the end of 2009. While the bank didn’t agree, it did expect the RBA to retain its tightening bias for some time. But in recent days the RBA has begun indicating the next move in rates will be lower, news that helped send the Aussie dollar tumbling below US90c.
In Evans’s view, the outlook still calls for the dollar to regain the mid 90c level against the greeenback by the middle of next year. He reasons that while the initial action on rates may be sharp, this first stage of the rate cutting process is likely to come to a halt by the first quarter of next year, with no more than 1.0% in cuts being delivered.
By then Evans sees the RBA as refocussing on inflation as its primary policy objective, which, along with a view the commodity cycle is not over and a US dollar recovery is not a fair accompli, should see sentiment again turn in favour of the Aussie currency.
In the case of the US dollar, it is Westpac’s view the problems with the housing and financial markets are not simply going to disappear overnight, especially as domestic demand is under some pressure. With respect to commodities, while there has been some slowing in growth among emerging nations in particular, the latest price action is viewed by the bank as a clearing of some of the speculative froth out of the market, which will be supported by what remains strong demand from developing economies.
As evidence of this, Evans points out while ocean freight rates have fallen 28% over the past 11 weeks, they remain 30% above the levels of May last year. This supports the view commodity demand will still be at high levels historically, even allowing for the pullback from recent peaks. This means price risk likely remains to the upside.
In terms of Aussie dollar, Evans also points out that the terms of trade improvement Australia has enjoyed from the boom in commodity markets have not yet been fully reflected in the currency. He reasons this should provide some support in coming months, as the terms of trade and the currency traditionally go hand in hand.
As well, there is scope for capital inflows to be very strong in coming quarters, as there is as much as A$40 billion on the books in potential cross-border merger activity in coming months. Inflows, which Evans notes, would be a major positive if they eventuated given the current financial crisis.
Adding all these factors together, the major change according to Evans is a new, lower starting point for the dollar, one where a recovery against the US dollar remains on the cards. While US87c in September is now the bank’s forecast, it expects a recovery to US90c by year’s end, US92c by the end of the March quarter next year and US95c by the end of June 2009.