Reserve Bank of Australia Governor Glenn Stevens, who cut interest rates twice last year to help manufacturers and consumers, is diverging from traders expecting a mining boom to lift the local currency to the most in more than 20 years.
Stevens welcomed the so-called Aussie’s surge versus U.S. and European peers as recently as November to hold down inflation. Now that strength is “a bit odd,” he said on Feb 24 in testimony to lawmakers. The RBA’s trade-weighted index climbed to its highest level since 1985 on March 2 and analysts raised their forecasts versus the U.S. dollar the most in almost nine months.
A weaker local currency would help companies including BlueScope Steel Ltd. and Billabong International Ltd. by making their goods cheaper overseas, easing political pressure on Prime Minister Julia Gillard as she tries to rebalance an economy dominated by natural resource exports. Anticipating inflows from foreign investors, analysts last month revised estimates for the Aussie to $1.04 by mid-year from a prediction of 99 U.S. cents in January.
Mining, Services Divergence
“Australian dollar strength will be a tough trend to fight in the short term,” Paresh Upadhyaya, director of currency strategy in Boston at Pioneer Investment Management Co., which has $210 billion in assets said by telephone Feb. 27. “The divergence between the mining sector and the service sector is getting worse. We believe the RBA will cut rates within the next two meetings to help alleviate some of the strain.”
Upadhyaya said he doesn’t plan on adding to his Aussie holdings.
Analysts raised forecasts for the currency even as a Credit Suisse Group AG Index based on swaps shows the RBA will lower its benchmark interest rate by 40 basis points, from 4.25 percent, within a year, the biggest easing for a developed market central bank after Sweden’s Riksbank. Policy makers cut rates by a total of 50 basis points in November and December before holding borrowing costs unchanged in February as Europe’s debt crisis showed signs of abating.
All 24 economists in a Bloomberg News survey said the RBA will keep the target rate unchanged at 4.25 percent at a meeting tomorrow.
The central bank is struggling to balance a slump in non- mining industries during the nation’s biggest resource-driven investment boom in a century. Australian manufacturing shrank to a record-low 8.6 percent of the economy in the first three months of last year and in the past three years households have saved at the highest rate on average in more than two decades.
“In the sectors that are not benefiting from the advantages that the higher commodity prices have brought, consumers are beginning to struggle with the stronger Aussie and higher inflation,” Ken Dickson, investment director of currencies at Standard Life Investments in Edinburgh, which manages about $235 billion, said on Feb. 27 by telephone. “Our expectation is the Aussie will weaken off through the year.” Standard Life doesn’t hold any Australian dollar positions, he said.
The nation’s auto exports plunged to the lowest since 1998 last year, leading to job cuts at General Motors Co. and Toyota Motor Corp.’s local units. Sydney-based David Jones Ltd., the nation’s second-largest department store chain, said Feb. 23 that second-quarter sales fell 3.1 percent as spending stalled and the strong currency made it cheaper for shoppers to buy from overseas websites. Retailers such as JB Hi-Fi Ltd. and Billabong (BBG) also blamed the economy for falling profits.
The slump is taking a political toll on Prime Minister Gillard, who withstood a leadership challenge from predecessor Kevin Rudd last month. Her Labor Party trails opposition leader Tony Abbott’s coalition by 10 percentage points, according to a Newspoll published in the Australian on Feb. 27.
The Australian dollar fell 0.5 percent to $1.0682 as of 11:04 a.m. in London, within 2 cents of $1.0856, the year’s high reached Feb. 29. It touched $1.1081 on July 27, the strongest since being freely floated in 1983. The local dollar traded at A$1.2353 per euro after gaining to A$1.2133 on Feb. 7, the highest since Europe’s common currency was created in 1999.
Compared with the currencies of 21 nations that account for at least 90 percent of Australia’s total trade, the Aussie reached a level of 79.3 on March 2, its strongest since 1985, an RBA index shows. The gauge has averaged 60.28 since the currency was unfixed.
A higher currency in part reflects overseas investors increasing holdings in Australian sovereign bonds to a record 80 percent in the third quarter of last year, according to central bank data. The nation’s 10-year note yielded as much as 4.13 percent, compared to 2.1 percent in the U.S. this year. Stakes probably rose to 83 percent in December, Nomura Holdings Inc. estimated Feb. 24.
Credit Agricole CIB, the most-accurate forecaster of the Aussie-U.S. dollar rate in the past two quarters, predicts the currency will end 2012 at $1.10. Australia’s bonds will continue to attract investors and the nation’s economy will benefit from a “soft landing” in China, Mitul Kotecha, head of global currency strategy in Hong Kong, said Feb. 28 by telephone.
Futures traders anticipate the Aussie will rise against the dollar. The difference between wagers on the currency strengthening and weakening advanced to a seven-month high of 78,201 in the five days ended Feb. 28, from 78,044 contracts at the end of January, according to Commodity Futures Trading Commission data.
Australian government debt produced the worst performance since June 2009 in February as investors favored corporate notes and equities amid signs of easing in Europe’s crisis. The bonds lost 1.1 percent, ranking 25th out of 26 sovereign debt markets tracked by Bloomberg/EFFAS indexes.
A Citigroup Inc. gauge of Australia’s terms of trade for commodities, which measures the price of exports relative to imports, fell 4.6 percent last month and reached its lowest since September 2010 on March 1. The RBA’s Aussie-denominated raw-materials price index dropped to 98.1 in February, the lowest since December 2010.
Terms of trade may see a further “modest decline” through the year along with slowing Chinese growth, said Emma Lawson, a Sydney-based currency strategist at National Australia Bank Ltd., the second most-accurate forecaster. NAB expects a decline to $1.03 in June and $1.01 by December.
Aussie May Drop
“At such a point where AAA sovereign demand stabilizes, the Aussie will move to better reflecting commodity prices,” Lawson said Feb. 28 by telephone.
That’s what policy makers are counting on.
“We do continue to ask ourselves whether what is happening in the currency makes sense,” Stevens said Feb. 24 to the House of Representatives Standing Committee on Economics. “The most recent bout of strength is happening at a time when the terms of trade have actually peaked and have started to come down.”
Stevens was echoing comments made after the RBA’s Feb. 7 policy decision, when he said that in trade-weighted terms the currency “is somewhat higher than the bank had previously assumed.” In November, when the RBA made its first rate cut since April 2009, he noted the currency’s strength and said it had contained inflation.
“It’s the first time that I can recall the RBA actually acknowledging that they feel that the currency has strengthened beyond what is justified by commodity prices,” Ray Attrill, head of currency strategy for BNP Paribas SA in New York, said Feb. 28 by telephone. “The RBA is jawboning.”
BNP forecasts the Aussie will trade at $1.05 by mid-year before rising to $1.12 by year-end.
The RBA on Feb. 10 cut its forecast for growth in gross domestic product to 3.5 percent from the Nov. 4 estimate of 4 percent. That would still be Australia’s strongest gain since 2007. The central bank said consumer prices will rise 3 percent, at the upper range of its target and less than a previous prediction of 3.25 percent. Price gains have averaged 2.7 percent since the beginning of 2009.
The estimates are based on the currency at $1.07, stronger than the RBA’s previous assumption of $1.03.
Predictions of lower growth take into account falling foreign demand. Exports to China, Australia’s largest trading partner, fell 13.4 percent to $6.3 billion in January, the least since May and down from a record $8.4 billion in September, according to Chinese government data.
Lower China Sales
While the Aussie’s strength has made manufactured goods costlier abroad, demand for commodities from Asian nations including China has bolstered the balance sheets of mining companies BHP Billiton Ltd., based in Melbourne, and Rio Tinto (RIO) Group of London.
“The China hard-landing scenario will come back into play and Australia is the most leveraged player on global growth right now, so it’s definitely going to be very vulnerable,” said David Woo, global head of rates and currencies at Bank of America Corp. in New York. “It’s a global demand and commodity price story that will drive the Aussie lower.”
Woo expects the currency to fall to $1.04 by June and trade at 98 U.S. cents in December.
China’s Growth Target
China’s government will target economic growth of 7.5 percent this year, the lowest goal since 2004, according to a speech that Wen Jiabao will read to about 3,000 lawmakers at the annual meeting of the National People’s Congress in Beijing today. By cutting the 8 percent goal maintained from 2005 to 2011, Wen is signaling the ruling Communist Party’s determination to shift the makeup of growth toward consumption and away from exports and investment.
Rio Tinto, the world’s third-largest mining company, is reviewing its Bell Bay aluminum smelter in Australia because of rising costs and declines in prices for the metal. Rio may shut the smelter, threatening as many as 600 jobs, the Australian Financial Review reported today, without citing anyone.
“The aluminum sector in Australia is facing tough market conditions in the form of a high exchange rate, higher costs of production and low aluminum prices,” Ray Mostogl, general manager at the Bell Bay operations said today in an e-mail, without detailing the options of the Tasmanian operation.
Dependent on Resources
Australia has grown more dependent on resources as employment in manufacturing dropped by about 30 percent since 2007, while mining and government rose by more than 50 percent, HSBC Holdings Plc estimates. An index of the nation’s services industry declined in February to 46.7, the lowest in almost a year, Commonwealth Bank of Australia and the Australian Industry Group said today. A reading below 50 signals a contraction.
BlueScope, based in Melbourne and the nation’s biggest steelmaker, stopped most exports and cut about 1,000 jobs. OneSteel Ltd. of Sydney, the second largest, said Feb. 21 it will focus to iron ore instead of its unprofitable steel unit, eliminating 430 jobs. Qantas Airways Ltd., Australia’s largest airline, said Feb. 16 it will lose about 500 positions in its maintenance and catering divisions.
Australia has “two very different economies, running at two very different paces, so the RBA has a challenge in terms of having a monetary policy that tries to fit all,” Callum Henderson, global head of foreign-exchange research in Singapore at Standard Chartered Plc said March 2 by telephone. “The continuing slowdown in China should, along with other factors, weigh on the Aussie and cause it to have a correction back toward the parity level.”
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