No Urgency to Cut Again in Australia, Despite Low Commodities

The Aussie dollar remains a tentative sell over the medium term, however the it is the strongest of the commodity

The Australian dollar has seen downside pressure in recent months due mainly to the fall in commodities prices. Being heavily reliant on resource exports, the Australian economy is negatively affected by lower commodities, especially the base metals. By having China as one of its key trade partners, the Australian economy is especially sensitive to fluctuations in demand from the behemoth economy.

This is evident in the price of the Aussie dollar – and all commodity-linked currencies – as a reduction in demand from China in recent months has diminished revenues for mineral exporting nations. Iron ore has fallen about $15 per tonne since having a pullback up to $64 in early June. This coincides with an approximate 500 pip fall in Aussie during the same period. Copper – another key export for Australia – is down at $2.43 and making fresh 6-year lows. These metals correlate positively with the Aussie dollar.

The Reserve Bank of Australia is currently on hold but within a longer-term easing cycle. They have cut rates twice this year – at total of 50 basis points. Currently the official cash rate sits at 2% with the Bank prepared to move lower if needed. The most recent monetary policy statement, released on July 7, was little changed from previous ones. They cited low commodity prices as putting downward pressure on the relative price of exports in terms of imports: “..key commodity prices are much lower than a year ago…Australia’s terms of trade are falling.” They saw economic growth at levels below the long-term average, together with weakness in business capital expenditure and spare capacity for some time.

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However they also stated that “inflation is forecast to remain consistent with the target over the next one to two years”. There was little market reaction to this rate statement because it contained no new information. In line with their usual rhetoric regarding the exchange rate, they said “Further depreciation seems both likely and necessary, particularly given the significant declines in key commodity prices.” Due to the regularity of such comments this did not have a bearish effect on the AUD.

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Indicators

On July 21 we saw the minutes from the July 7 meeting. The minutes contained little in the way of new monetary policy insights. They touched on improvements seen in the labour market and saw no need to cut rates in the near future. However on July 22, Governor Stephens reiterated that rate cuts were still a real option for the Bank. This was not new language from the RBA head. We have heard this rhetoric from Stephens on several occasions since the last cut in May. Overall, the minutes indicated that rates will remain on hold for the foreseeable future, until such time the data calls for a change.

On July 22 CPI came in close to analysts’ estimates. The headline figures slightly missed economists’ consensus for both the q/q and y/y readings, however the Trimmed Mean – the Bank’s preferred measure of inflation – slightly beat expectations from a survey of Bloomberg economists by printing at 2.2% for the y/y figure. This is down from the Q1 y/y figure of 2.3%. The inflation situation does not provide any clear direction in Aussie nor any clues about future policy. It was a rather benign release and just adds to the case of rates being on hold.

Employment figures for June showed slight beats on both the change and unemployment rate. This again relieves any pressure to ease policy further. Gross domestic product for the first quarter, released on June 3, also beat expectations. Although the headline growth reading impressed economists, the breakdown was less positive; it showed that non-mining investment failed to fill the gap left by the downturn in mining, and the prior week’s Capex data signalled that this shortfall will remain for the coming year or so. Some analysts expect growth for the rest of 2015 to drop sharply as the effects of the end of the mining boom trickle down through to the consumer.

Our bias for the Australian dollar remains slightly bearish, mainly due to waning demand from China and associated drops in industrial metals prices. In terms of economic data, the picture painted by recent jobs and CPI readings shows the economy is ticking along relatively normally. However, the effects of the end of the mining boom will likely be felt throughout the rest of the year and this may be reflected in the next set of growth figures. Private Capital Expenditure is due on August 27 and may provide some insight regarding business investment. The Aussie dollar remains a tentative sell against USD and GBP over the medium term, however the currency is the strongest of the commodity currencies at the moment.

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