By Scott Boyd
The outlook for Europe and the U.S. remains mixed, but on one thing all pundits can agree: 2011 will be Australia’s year. And even though the new year got off to an auspicious start with floods and other bouts of terrifying weather, Australia’s economy is well-positioned to continue to expand at an accelerated rate. In fact, the Reserve Bank of Australia (RBA) recently revised its 2011 growth forecast.
Noting that the recent floods and the expenses incurred in the aftermath will have a “material effect on the near-term profile of gross domestic product," the RBA predicted that by June the economy will be expanding at an elevated clip. The RBA now projects the economy to grow by 4.25 percent in 2011 from its estimate late last year calling for 3.75 growth. The RBA also notes it expects consumer prices to climb by 3 percent compared to its earlier estimate of 2.75 percent.
The revised outlook had an immediate impact on the Australia dollar as investors increased the odds of an interest rate increase. The current benchmark rate – known as the Official Cash Rate – is 4.75 percent and already far exceeds rates in western regions. The Official Cash Rate sets the interest that financial institutions borrow money on the overnight market at; a change in the cash rate has a trickle-down impact on retail rates. The extremely aggressive stance by the RBA is seen by the Street as a strong hint that the Overnight Cash Rate will be pushed higher within the next few months.
Aussie Dollar Outlook
For 2010, the Australian dollar – with the exception of the Japanese yen – made significant gains against the major currencies. The outlook for 2011 calls for much of the same:
|Currency||Jan 2010||Dec 2010||Percent Change|
To understand the RBA’s reasoning, one need only consider the impact an expected increase in shipments of coal and iron ore to China will have on Australia’s exports. Even though China has made attempts to slow the pace of growth, its insatiable appetite for the resources its all-important heavy manufacturing sector relies upon will continue to expand. Australia is well-positioned from both a resources standpoint and geographically to benefit.
There is a dark cloud in what is otherwise a very sunny outlook: The higher Australian dollar adds to the cost of all exports, and for markets unable to so easily absorb these extra costs, a decline in foreign sales is unavoidable. This has already become an issue in the manufacturing sector, which has seen several months of declining sales.
Inflation is also a concern, and while the RBA expects to contain expansion to within an acceptable rate, the prospect of further interest rate hikes is considered highly probable. In this age of low yields in Europe and the United States, expect investor interest in Australia to spike even more in light of the RBA’s latest assessment.