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Australia Growth Cushion Deflates as Aussie Keeps Gains: Economy

Australia Growth Cushion Deflates as Aussie Keeps Gains
Resilience in the currency, supported by its increasing use in foreign-exchange reserves amid global financial strains, deprives Australian exporters of the competitiveness provided from exchange-rate depreciation should economic growth slow. Photographer: Brendon Thorne/Bloomberg

Australia’s currency, historically a shock absorber for the world’s 13th-largest economy, may be losing some of its elasticity, increasing the likelihood that the central bank will consider cutting interest rates.

The so-called Aussie remains up for the year even as Australia’s No. 1 customer, China, sees a deepening slowdown and falling prices for iron ore and coking coal erode the nation’s terms of trade -- a measure of windfall gains from exports that reached a 140-year high last year.

Resilience in the currency, supported by its increasing use in foreign-exchange reserves amid global financial strains, deprives Australian exporters of the competitiveness provided from exchange-rate depreciation should economic growth slow. Declines in the Aussie in 2008, 2001 and 1998 helped Australia maintain its recession-free record since the early 1990s.

“What you would expect it to do is fluctuate with export commodity prices in particular and provide a kind of automatic stabilizer,” said Ray Attrill, global co-head of foreign-exchange strategy at National Australia Bank Ltd. in Sydney. “If that mechanism is no longer working, then, arguably the RBA would have to say ‘well now we have a currency problem that we have to deal with’” at some point, he said. For now, “they don’t think there’s a problem,” he said.

Traders are pricing in a 75 percent chance that the Reserve Bank of Australia will cut borrowing costs by another 50 basis points by year-end to 3 percent, matching the 50-year low the benchmark reached at the height of the global financial crisis.

Surprising Stevens

RBA Governor Glenn Stevens told lawmakers last week he was “a little surprised” at the Aussie. The currency was at $1.0329 as of 5:25 p.m. in Sydney, up 1.2 percent for the year. It has climbed 72 percent from its global credit-crunch low of 60.09 U.S. cents in October 2008, making it the best performer of 16 major currencies tracked by Bloomberg.

The local dollar’s strength has propelled it to the widest divergence in more than a decade from Australia’s terms of trade, and also left it out of step with a drop in government bond yields.

“Historically, we were places you ran away from when risk was perceived as growing,” Stevens said in Canberra Aug. 24. “Official flows” into the Aussie recently have bolstered the currency, he said, referring to central banks and other government institutions that typically are “not usually the most adventurous” of investors.

Recession Risk

Meantime, the Chinese slowdown and drop in commodity prices may send the nation’s terms of trade down as much as 15 percent in the final three months of 2012 compared with a year earlier, Deutsche Bank AG economists said last week. In the past half century, such a decline occurred five times, with three of the episodes resulting in a recession.

A government report today underscored a slowdown in the nation’s housing market, with building approvals tumbling 17.3 percent in July from a month before, the most in almost a decade. A separate release showed that business investment rose 3.4 percent in the second quarter from the previous three months, less than half the prior gain.

The RBA next sets rates Sept. 4, and is seen holding its fire for now, with 19 of 20 economists surveyed by Bloomberg News predicting the bank will hold the benchmark rate at 3.5 percent, the highest among major developed nations.

While Australia has benefited from trade ties to the region that’s led the world economy in recent years, Asia-Pacific nations haven’t been immune to the global slowdown. The Philippines today reported its gross domestic product rose 5.9 percent in the second quarter from a year before, down from a revised 6.3 percent advance in January-to-March.

Korean Confidence

South Korea reported today manufacturers’ confidence for September stayed near the lowest level since the 2007-2009 world credit crunch. Japan’s retail sales fell more than economists forecast in July.

Elsewhere, European Commission data reiterated confidence in the euro area is at the lowest in more than three years this month. Germany, which has benefitted from declines in the euro that have bolstered its export competitiveness, said the adjusted jobless rate was unchanged at 6.8 percent in August.

After growing more than previously estimated in the second quarter, the U.S. economy may show more signs of improvement. Initial jobless claims probably fell last week, while personal spending climbed in July by the most in five months, surveys indicated before reports due today.

Cinderella Currency

Europe’s debt woes have propelled demand for the Aussie, making it “the Cinderella in what is a world’s least-ugly contest” among currencies, said Jarrod Kerr, director of Australia rates strategy at Credit Suisse Group AG in Singapore. At the same time, a more pronounced global crisis would probably send the local dollar lower, he said.

“We’ve had this kind of structural shift higher,” Kerr said. “It will definitely fall. No question in that scenario. But it will probably be in the 80s not the 60s.” He predicts the currency will trade in a band of 95 U.S. cents to $1.06, barring a major offshore shock.

Switzerland’s central bank is among those piling into the Aussie, according to the RBA. As a share of the reserves whose allocations are reported to the International Monetary Fund, holdings of “other currencies” -- a category that includes the Canadian and Australian dollars -- reached 5.2 percent in the first quarter, compared with 2 percent five years earlier.

Historical Cushion

The Aussie tumbled 20 percent in 2008 as the accelerating collapse of the U.S. mortgage market triggered a freeze in credit and the deepest global recession in the postwar period. As the U.S. slid into contraction after its technology-bubble burst in 2001, the Australian currency lost 8.8 percent, on top of a 15 percent decline the year before. Over the 1997-1998 Asian financial crisis, it depreciated 23 percent.

Richard Grace, chief currency strategist and head of international economics at Commonwealth Bank of Australia in Sydney, said one reason the currency is disconnecting this time is that it failed to keep pace with commodity export prices on the way up.

“The Australian dollar never followed the terms of trade right to its peak, so when the terms of trade started to come down a bit, then it was less of a force driving the Australian dollar down,” he said.

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