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Depreciated Aussie Dollar Sets Scene for Economy

The consistent depreciation of the Australian dollar over the last year is setting the scene for the Australian economy. Driven lower by fundamental influences like interest rate differentials, the Aussie seems set to be lower for at least the medium term. Implications are already being felt in the forestry and wood products sector.

As the chart below shows, the Australian dollar has depreciated against its major trading currencies, especially the US dollar. In August, at USD0.726, the Aussie was 2.3% lower than a month earlier and compared to a year before, was 8.1% lower.

fig1

To go straight to the dashboard and take a closer look at the data, click here.

The path down has been similar but less steep against the Euro (7.7% over the year) and the Yen (6.6%), but the trends are consistent, and linked to the US dollar. In many respects therefore, though we focus attention on the Australian dollar, the real picture is that the US dollar has appreciated strongly over the last year. In many respects this has been the result of a strengthening US economy.

Exporters are earning more revenue in Australian dollars as a result of the depreciated currency. With woodchip and log exports at their highest ever levels, rising prices and revenues are very welcome.

Imported wood products, especially sawn softwood products, are becoming more expensive in Australian dollars. That has aided local producers to increase their prices, in line with global pricing that is demanded by major importers, the majority of whom are from Europe and Scandinavia.

Those importers are not desperately searching for a home for their timber, meaning they ship to Australia when they earn equivalent revenues to other destinations. That has driven higher prices, even as import volumes have risen.

So, what are the prospects for the local currency over the next year, and what are the factors driving it?

As one of the world’s most traded currencies, the Australian dollar is prone to large movements over the course of any year. It often trades in a band of plus or minus 20% of its starting point over a full year. That is why consistent movements in largely one direction are so significant.

The Australian dollar is being traded, but most importantly, is subject to global movements that are impacting it. The most significant of these is US interest rates, which continue to be increased in line with a program set out by the US Federal Reserve Bank.

Commentators widely anticipate at least three more lifts for US interest rates by the middle of 2019. In Australia, there is no such expectation of rising interest rates over that period, although the Reserve Bank of Australia’s Board appears to be on a ‘neutral’ stance, with their bias more toward rate rises than any further decrease.

In September 2018, the target interest rate of the US was 2.0% to 2.25% after the third rise of 2018. In Australia, the target interest rate 1.50%. If the US proceeds with its interest rate increase cycle – and it shows every indication it will do so – the US target band will be headed toward 3.5% by the end of 2019.

If that eventuates, the Australian dollar will trade even lower with the US dollar, with flow-on effects to other major currencies. The implications of that eventuality are fundamental to the strength of the Australian economy.

 

Posted Date: October 10, 2018

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