Low Prices For Raw Materials Putting Pressure On The Central Bank Of Australia

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Includes: AUSE, CROC, EWA, FXA, IAF
by: Societe Financiers

Summary

The current value of the Australian dollar does not allow Australia to fully realize its export potential.

The risk of revaluation of the Australian currency rapidly increases against the backdrop of falling exports.

Growing demands from Australian authorities provide additional incentives to support Australian exporters and business in general.

On April 19, the Australian dollar rose to a 10-month high against the US dollar. The strengthening of the Australian dollar, in our opinion, is associated with the positive dynamics of iron ore prices, the main Australian export.

Iron ore went up to $60 per ton after the publication of information about the increase of Chinese imports as well as the positive statistics on the average housing prices in 70 major cities in China. Since iron ore is widely used for the smelting of materials for construction, the improvement in property prices will increase the number of construction projects and, as a result, the consumption of iron ore.

(Source: stockchart)

The strengthening of the AUD had a big impact on the condition of Australian exports. It also should be noted that the current value of the Australian dollar does not allow Australia to fully realize the country's exporting power. A further decline in exports may lead to a revaluation of the country's currency and the slowdown in its economic growth. In this case, the central bank will have to take decisive fiscal and monetary actions.

(Source: tradingeconomics)

(Source: tradingeconomics)

In our opinion, one of the reasons that stopped the Bank of Australia to lower the interest rate on April 5, 2016, was the downward trend in the unemployment rate. In March, the unemployment rate was 5.7%, the lowest level since September 2013. In this case, the monetary policy aimed at easing economic conditions contributes to a reduction in unemployment and increasing wages, which negatively affects the profits of exporters.

(Source: tradingeconomics)

Also, during the last meeting of the Reserve Bank of Australia on April 5, 2016, it was noted that the growth of the AUD against other currencies is associated with stimulating monetary policy in other countries. This is primarily due to the introduction of negative rates in Japan, which prompted the chain of currency devaluations in the Asia-Pacific region, as well as statements about the ECB's sentiment regarding an increase in stimulating the region's economic growth.

Currently, the Bank of Australia has taken a break, expecting economic growth driven by an increase in crude oil prices. In our opinion, in the medium term, even though the condition of Australian imports is beginning to stabilize, one should not expect high economic growth rates and increases in demand and prices for raw materials.

Moreover, Australia has a typical problem found in developed countries: namely, the large external debt, according to the most recent data, is equal to 60% of the country's GDP. This, in combination with the reduction in investment demand for Australian raw materials, gives rise to expectations of fiscal consolidation and measures aimed at the reduction of the budget deficit.

Conclusion

In the medium term, we expect that the Central Bank of Australia will lower interest rates due to the lack of demand growth for iron ore and steel. We believe that, at this point, we can expect a proactive fiscal policy from the government, which is included in the list of non-standard monetary measures. On July 1, the government intends to introduce tax incentives for foreign investors who invest in developing businesses in Australia. These measures will likely lead to lower interest rates and help drive Australia's GDP.

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