Australian dollar review - 2011

[John from Moneycorp]

Hi all

 

As 2011 draws to a close, please see below a review of the Australian dollar which covers the past year - thanks.

 

Aussie dollar – 2011

 

The Aussie dollar has had a good ten-year run, strengthening from 3 to the pound in October 2001 to 1.5 to the pound in October this year. It has doubled in sterling terms and is currently overvalued by an estimated 15.5%, according to America's Peterson Institute.

 

Three forces took it higher. Australia's economy grew steadily, even when the global financial crisis knocked most developed economies into recession. There was growing demand for Australia's exports, particularly from China with its insatiable appetite for iron ore and coal. And relatively high interest rates attracted "hot" money from investors who could earn better returns than those available in other major currencies. Over the 2001-11 period the Reserve Bank of Australia's benchmark Cash Rate was on average 1.7 percentage points higher than the UK Bank Rate.

 

It is possible that long run of success might have come to an end. Since its record high in August the Aussie dollar has oscillated across an 8% range between 1.50 and 1.63. Twice the pound has rebounded from 1.50, suggesting ongoing interest to sell the AUD at that level. The three forces that took the dollar higher are now all overhung with question marks. Interest rates in Australia are pointing lower. In November the RBA made its first rate cut in more than two years and the smart money is on further reductions to come. The speculators who chased the Aussie higher because of rising rates could decide to move on now that rates have gone into reverse. The main reason for the RBA's decision to relax monetary policy was that Australia's recession-proof economy is not as ebullient as it has been. In three single quarters of the last three years economic growth has been zero or negative. House prices have passed their long-overdue peak and declined by -2.2% in the year to September.

 

There are also worries about demand from Australia's biggest customer, China. A particular cause for concern is that the failure of the European Union to resolve the vexed problem of Greek government debt risks tipping the euro zone into recession next year. A new recession in Euroland would be less easy for Australia to dodge than the one in 2008-09, according to the RBA's John Edwards.

 

Looking ahead

 

It is unlikely that the Aussie dollar's performance during the coming year will resemble that of the last ten. If the EU gets its act together and avoids recession, and if continued demand for Chinese products leads to steady demand for Australian raw materials, the AUD might be able to hang onto its position in the currency food chain.

 

However, if it all goes to pot in Euroland the Aussie will struggle. That 15.5% overvaluation is unlikely to survive the next 12 months.