There's no secret why Glenn Stevens, governor of the Reserve Bank of Australia (RBA), cut the cash rate by 25 basis points (bps) to 3.25% on Wednesday 2 October 2012 -- to use his own words "investment in dwellings has remained subdued", prices for non-residential real estate have remained weak, the labour market is softening and the exchange rate has remained stubbornly high. What he didn't spell out is that manufacturing is falling off a cliff due the the high exchange rate and Australia's main export industries are rapidly following manufacturing over the same cliff. Lowering the exchange rate may aid manufacturing industry, but it's not going to turn the balance of payments deficit around. And the little Aussie battler will continue to remain "stubbornly high."
Why then is the Aussie dollar holding up so well, much to the displeasure, we presume, of Governor Stevens? On Thursday 4 October the A$/US$ rate was 1.0213. For one thing, the Aussie dollar is one of the top ten traded currencies in the world, despite the fact that many economies are bigger than Australia. This means that the Aussie dollar doesn't always trade on its fundamentals.
Second, even though interest rates are, by Australian standards, low they are still higher than Japan, for example. This gives rise to the carry trade, where Japanese housewives borrow in yen and buy the Aussie dollar, trading, so it is said, on their cell phones.
Third, a growing number of central banks now hold the Aussie dollar as a core holding of their reserves, as it is seen as a stable currency with good fundamentals (well, better than most) and Australia has a relatively low level of sovereign debt.
Fourth, it's likely the RBA will cut by 25 bps towards the end of 2012 but anything more than that would be regarded as a sign of desperation. An Australian version of quantitative easing (QE) is unlikely, so the Aussie dollar is likely to remain supported in foreign exchange (FX) markets as a hard currency. The Swiss franc is too hard, even for the Swiss who have been buying euros to hold it down. The Aussie dollar may not by the Pacific franc, but it's certainly no longer the Pacific peso. Given an inflation rate of 1.2% and positive interest rates, the Aussie dollar is looking better than a lot of other currencies. With the US rolling out QE3 and the near certainty it will lose its AAA rating some time next year, the world's central banks will be looking for a safe haven for their money.
What are the negatives for the Aussie dollar?
Australia's main export commodities are in retreat. Coal volumes are falling and iron ore shipments to China are in retreat. International grain prices are excellent, with droughts in the US and Russia, but growing conditions in southern and western Australia have been patchy. Gas is being promoted, but the US will start shipping shale gas to Asia from 2015 at half Australia's price. The US is likely to become a net gas exporter and US crude production is at 6.52 million barrels per day, a 15 year high according to Australian stockbroker Ord Minnett. Australia has developed a structural deficiency in liquid petroleum and the international petroleum giants are shutting down their small, outdated Australian refineries, meaning more imports of processed petroleum products. In the last balance of payments figures, Australian showed a shock $2 billion deficit.
New spending programs announced so far this year by Julia Gillard's Labor government will punch a $20 to $25 billion hole in the Budget. Even her own backbenchers are getting worried, as tax revenues are beginning to fall sharply. Revenues from the mining tax will not meet expectations. The ALP is trying to buy the next election, hoping the electorate won't ask "who's paying the bill?"
The Australian housing market is looking weak, with anecdotal evidence of dramatic falls in residential property prices in the resource-rich states of Western Australia and Queensland, which have been carrying the rest of the nation. Real estate prices in Queensland coal towns have halved and the locals are moving back in. Prices in New South Wales and Victoria, the two most populous states, remain soft. Prestige properties (over $2 million) have been especially hard hit. As residential property is the main asset class for the Big Four banks, any dramatic fall in residential property prices would destablise (but not bankrupt) the Big Four banks and possibly wipe out some of the minnows. (See 'Time to short Australian residential property?)
One thing you can say about Australia, at least at the Federal level, is that outright thievery is rare. The RBA, despite its marginal involvement in the polymer banknotes scandal, is both honest and transparent The Australian Prudential Regulation Authority (APRA) now supervises authorised deposit taking institutions If Australia was as good at building companies as it is at building bureaucracies, we would all be far richer.
Thus, the Aussie is unlikely to fall markedly, at least in the short to medium term. One suspects that Governor Stevens will soon be getting a few worried calls from Treasurer Wayne Swan to "do something." but there's not going to be much he can do. The RBA is a statutory body that is independent of the Federal Government and what Wayne Swan wishes is unlikely to overly sway RBA Governor Glenn Stevens.
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