Aussie Dollar Thumped by Devalued Yuan May Be a Mixed Blessing

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The Aussie dollar’s plunge to a six-year low may not be all good news for the Reserve Bank.

While the Australian central bank spent much of this year calling for a weaker currency to help revive the local economy, the Chinese move to devalue the yuan that sparked the most recent drop underscores the dangers posed by a slowdown in the South Pacific nation’s biggest trading partner. It also risks fueling beggar-thy-neighbor actions in other countries and putting the brakes on a normalization of U.S. monetary policy.

“Your first temptation would be to say lower Australian dollar, job done, the RBA doesn’t have to ease again, but I think you have to think a bit more deeply than that and say: Why is the Aussie dollar lower?” said Andrew Ticehurst, a Sydney-based strategist at Nomura Holdings Inc. “Is it lower because we could have regional currency wars? Is it lower because commodity prices look like they’re falling? Could we be seeing more rate cuts in the region?”

China’s surprise change to its currency regime on Tuesday rippled through global markets as investors speculated the move was timed to combat the deepest economic slowdown since 1990 for the world’s most populous nation. The Australian dollar dropped almost 10 percent this year to 73.80 U.S. cents as of 4 p.m. on Thursday in Sydney, having touched 72.16 cents on Wednesday, a level unseen since April 2009.

China Devalues

The Aussie fell after the People’s Bank of China cut its yuan reference rate to the weakest level since 2012 and sparked the renminbi’s biggest two-day decline in two decades. Australia’s dollar was little changed Thursday as the yuan stemmed losses after China’s central bank stepped up verbal support for the currency and said it will step in when the market sees excessive volatility or becomes swayed by herd behavior.

The PBOC’s previous announcements rattled the currencies of commodity producers and emerging economies around the world.

“You’ve seen renewed weakness in the Aussie dollar and so I think the RBA would be happy to see the currency slide further,” said Kieran Davies, Barclays Plc’s chief economist in Australia. “The question is to what extent the Chinese move reflects a weaker Chinese economy.”

RBA Deputy Governor Philip Lowe said that it was “hard to tell” what the implications of the PBOC’s move would be for Australia.

Watching Carefully

“It partly depends upon what’s driving this change, if it supports growth in our largest trading partner, it’s probably good,” he said in response to questions at an event in Perth on Wednesday. “We’ve all got to watch what’s going on very carefully, particularly in Asia, because many currencies have adjusted in the last couple of days.”

Australia is suffering from a drop in commodity export prices and a decline in mining investment, and the central bank last week pushed back by a year its forecasts for an upswing in growth. While the currency depreciation seen so far has provided “some assistance” to other areas such as service exports, the economy “is likely to be operating with a degree of spare capacity for some time yet,” the RBA said in its quarterly economic update, before the latest PBOC moves.

Longer term, China’s actions will help spur growth, said Peter Jolly, head of market research at National Australia Bank Ltd.

Easier Policy

“Easing monetary policy is actually good for the Chinese economy,” Jolly said. “It takes away the need for the RBA to cut interest rates further.”

The RBA has signaled a reluctance to cut the cash rate below an already record-low 2 percent and investors remain divided about the prospect of further reductions. Swaps market pricing indicates a 50 percent chance that the benchmark will be 1.75 percent or lower by the end of March 2016, according to data compiled by Bloomberg.

“The Aussie dollar is responding to a negative shock emanating from China,” said Matthew Peter, Brisbane-based chief economist at QIC Ltd. “The devaluation of the renminbi against the U.S. dollar has to be matched by a devaluation of our currency to maintain our competitiveness with China. The RBA will have to wait and see how that pans out, if it’s enough of a compensation.”

(An earlier version of this story was corrected to change wording in the fifth paragraph.)