Is the Australian dollar about to crash on the foreign exchange market? These are the rumours that are circulating at present, as the AUD seems to run out of steam following months of astonishing gains against both the pound and euro. In the past fortnight for instance, instead of continuing the steady climb that has characterised the Australian since the financial crash in 2008, it has merely held its ground against its rivals. This suggests that change is a-coming. But what is causing this sudden loss of momentum in the AUD, and what might happen in the future?
China and Foreign Exchange Ch-ch-changes
One reason the Australian dollar is starting to resemble a steam train without coal is a recent slowdown in Chinese economic growth.
In recent years, China has fuelled massive gains in the Australian mining industry (sending the AUD through the ceiling) as it expands its manufacturing base and Chinese living standards rapidly improve. But in recent months, Europe (China’s biggest export market) has entered recession, killing demand for Chinese products and hence reducing Chinese manufacturing output. This, in turn, has slowed the incredible gains in Australian mining (and stopped the AUD in its tracks.) Of course, China is still expanding at a rate most industrialised countries would drool over (around 7.0%-8.0%.) So it is hardly as though demand for Australian commodities is about to dry up. But the pace looks set to be more modest.
The AUD has also come under pressure because of increasing concerns that Australia is developing a two-speed economy.
On the one hand it is true that expanding mining has shielded Australia from the global economic crisis: it avoided recession in 2008 unlike most industrialised nations for instance. But on the other hand, sectors including manufacturing and retail have come under increasing pressure as the dollar rises, causing thousands of people to lose their jobs. This has created an attitude of caution among consumers, leading to disappointing retail sales and the impression that, mining aside, Australia is little better off than developed economies in Europe or the US.
What Comes Up…
Last of all there is the simple fact that, even in foreign exchange, things must obey the laws of the markets.
According to indexes including The Economist Big Mac index (measuring the relative worth of currencies according to the price of a Big Mac) the Australian dollar is overvalued up to 40.0% at present, as investors seek secure locations for their cash. In short, this momentum just cannot continue. Eventually, the exorbitant price of the AUD is likely to overshadow its attractions, prompting demand and then value to decline. Supply and demand at its best!
This guest post was contributed by Michael Smith at foreign exchange specialists Pure FX.