Photographer: Ian Waldie/Bloomberg

Australia's Hidden Stimulus Boosts Economy as Currency Lags Commodity Rebound

`It makes sense for the RBA just to watch and wait.'

Australian policy makers were publicly frustrated by the currency's stubborn strength when commodities tumbled earlier this decade.  Now they're conspicuously quiet as it fails to keep pace with resurgent resource prices.

Since the end of June, JPMorgan Chase & Co.'s real effective exchange rate for the Aussie has risen 4 percent, while Westpac Banking Corp.'s Australian export commodity index  has soared by 43 percent. The mismatch is another reason why central bank Governor Philip Lowe is comfortable sitting on his hands: he's getting an easing of financial conditions without having to touch the monetary policy lever.

Indeed, money markets now see little chance the Reserve Bank of Australia will cut interest rates from the current record-low 1.5 percent next year; in fact they're pricing in some possibility of a hike in November and December.

``Normally, it's a drop in the currency that gives a bit more stimulus to the economy; but in this case it has gone up -- just by not as much as commodity prices -- and that's delivering the boost,''  said Sally Auld, head of fixed-income and currency strategy for Australia at JPMorgan.``Given how important the whole terms of trade dynamic has been for the economy and the currency, it makes sense for the RBA just to watch and wait.''

Australia's economy is enjoying an unexpected windfall from this year's almost 300 percent surge in coking coal prices after output from China, the world’s biggest miner, tumbled amid government pressure to cut overcapacity. Meanwhile the price of iron ore, Australia's biggest export, has jumped 70 percent over the period. That's sparked a rebound in the terms of trade, or the ratio of export prices to import prices, a key determinant of national income that had been declining for 2 1/2 years.

Skeptics say that coal is unlikely to sustain its rally, citing concerns about bad weather shutting production in the key state of Queensland this quarter and next as factors shoring up the price. They also point to the RBA failing to upgrade its economic growth and inflation forecasts at this month's quarterly review, suggesting it has little faith in the longevity of the spikes. 

But in the meantime, Australia is enjoying strong services exports from its southeast together with a windfall from commodity prices in its north and west, which is helping to rapidly improve the country's trade picture. That's likely to keep the RBA on the sidelines for some time yet.

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