Monthly economic e-news – October 2018
18 October 2018
By Craig Turnbull
Chief Investment Officer
Is the falling Australian dollar so bad?
Rising interest rates in the US have unsettled investors this year with increasing volatility across global markets but it’s also had an impact on the Australian dollar.
On Australia Day, our dollar hit US$0.81 but it’s been on a steady decline ever since with the exchange rate falling by more than 11% by the end of September, but many argue that a lower dollar may not be such a bad thing.
Source: Reserve Bank of Australia
Why are US interest rates driving down our dollar?
The main reason for our weakening dollar is the widening gap between official interest rates in the US and here in Australia.
In response to strong growth and tax cuts, the US Federal Reserve has lifted the federal funds target range three times this year to 2.0-2.25%. Meanwhile the Reserve Bank of Australia has kept our official cash rate at 1.5% for more than two years.
The higher rates in the US are attracting more foreign investment and driving up the demand for US dollars putting pressure on a wide range of currencies including the Australian dollar.
At the same time, there’s been a sharp drop in Chinese commercial investment in Australia, down from $14.9 billion in 2016 to $8.9 billion in 2017, increasing the pressure on the dollar.
However, the falls have not been as severe as they could have been mainly due to resilient global prices for some of our key exports. The spot price for iron ore for example has risen over recent months, reaching US$68 per tonne in September.
What is the impact of a falling dollar?
The most immediate impact of a falling dollar is on the prices of imported goods. It’s logical that retailers faced with rising costs will bump up their prices to maintain their margins but it’s not always the case.
Petrol retailers are often the first to increase their prices as the demand for petrol is not as sensitive as the demand for less essential goods. Motorists have been feeling the pinch as the Australian dollar falls while global oil prices have continued to rise.
In contrast, retailers in more competitive markets can be quite reluctant to pass on the extra costs immediately and this can affect their profit margins. But the reality is that if the dollar keeps falling, price rises across the economy become inevitable, and this can erode consumer confidence.
On the plus side, a lower Australian dollar helps make our goods and services more competitive on the global market.
It usually means better value for international students and cheaper holidays for foreign tourists. That’s good news for our education sector that employs around 8% of our workforce, and for tourism which contributes more than 3% to our GDP.
Export-orientated companies that earn a larger proportion of their revenue in US dollars may also benefit a lower Australian dollar. This would include some of the big miners, and companies such as Cochlear, CSL, Brambles and Macquarie Bank.
What is the outlook for the Australian dollar?
Analysts are split on the outlook for the dollar. Some argue that the worst of the falls are over and expect the dollar to settle around the US$0.70 mark.
While others are more pessimistic, predicting that the increasing interest rate differential between the US and Australia, and the ongoing trade war between US and China may drive the dollar down as low as US$0.65.
But nearly all agree that in the current climate of global uncertainty, we’re unlikely to see any significant rise in the Australian dollar over the short term.
Markets at a glance
for the month ending 30 September 2018
Australian shares 1 down by 1.26%
Australian Government Bonds yield2 up to 2.670%
Australian dollar down to US$0.7222
Cash rate3 steady at 1.50%
International shares4 up by 0.45%
1 ASX 200 Accumulation Index
2 Yield on 10 year Australian Government Bonds
3 RBA cash rate
4 MSCI – World ex Australia (USD)