Last updated: February 19, 2014 8:13 pm

Australian central bank walks a currency tightrope

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When Italian football star Alessandro Del Piero quit Juventus for Sydney FC in Australia in September 2012, he may have had currency markets on his mind. The Australian dollar had just hit a record high against the euro, making his A$2m-a-year salary all the more attractive.

Since then, slowing growth in China – Australia’s biggest export market – and a central bank campaign to weaken the currency have taken their toll. Mr Del Piero has seen his earnings drop by 20 per cent in euro terms.

Crying foul

Crying foul

The fall in the Aussie has come too soon for the country’s foreign sports stars, but too late for its manufacturing industry. Over recent months Toyota and General Motors’ Holden unit have both decided to close their Australian factories by the end of 2017, which will end a 100-year tradition of making cars in the country.

This week Alcoa said it would close its Point Henry aluminium smelter with the loss of more than 1,000 jobs. Like the carmakers, Alcoa included the strength of the Aussie dollar during the country’s decade-long mining investment boom among its reasons for deciding it was not financially viable to keep the smelter operating.

The industrial sector may yet see brighter times – most analysts expect weakness in the Aussie over the next 12 months. ANZ’s currency team are “structurally bearish” on the currency and expect it to trade down to US$0.84 this year.

But the currency has hit a pocket of renewed strength against the US dollar in February. Since the start of the month, it has gained about 3 per cent to above US$0.90, its highest since early December.

The Aussie is widely considered a proxy for Chinese growth due to its exposure through commodity exports, so better economic data on the mainland has provided a boost. China’s trade numbers last month beat forecasts, while an unexpected boom in bank lending to start the year has prompting some investors to trim their bearish positions in the Aussie dollar.

“The rally has been predicated on people getting out of their short positions, and some better indications in the meantime from China,” says Sacha Tihanyi, FX strategist at Scotia Bank.

Meanwhile, the Reserve Bank of Australia’s campaign to weaken the currency via dovish rhetoric appears to have been put on hold due to worries about rising prices. Underlying inflation was 0.9 per cent in the fourth quarter and 2.9 per cent year on year – far higher than expected – leaving the RBA with limited room for manoeuvre.

“You can talk the currency down when you’ve got a fairly benign inflation profile, but once we got the [fourth-quarter] data – which showed a very strong upside surprise – all of a sudden you have to walk a bit more of a tightrope”, says Jonathan Cavenagh, FX strategist at Westpac.

The RBA’s own policy statement following the inflation reading showed a clear change in language towards the strength of the currency.

“I think the tone of the RBA’s commentary on the Australian dollar has shifted significantly since the upside surprise in the CPI numbers last month,” says Paul Bloxham, chief economist at HSBC bank. “I think the campaign to jawbone the Australian dollar lower is over, at least for the moment.”

The RBA now faces a trickier balancing act. While house prices are rising fast and consumers increasingly confident, the jobs market remains weak and wage growth tepid. Any move to cut rates to support economic growth risks further stoking inflation and property prices, while a rate increase would prompt renewed strength in the currency and delay much needed rebalancing.

“One of the potential risks on the upside for the [Aussie] dollar later this year is an increase in capital flows from Japan. This could be driven by signals from the RBA of a possible interest rate increase later in the year,” says Martin Whetton, rates strategist at Nomura.

Analysts say the RBA is likely to tolerate short-term strength up to about US$0.93, in spite of a previously stated preferred level of about US$0.85, but it may yet be forced to resume its linguistic intervention.

“If the RBA perceived a big speculative push to be long Aussie again, and financial interest driving a wedge between [the strength of the currency and] what they see as the fundamental interests of the economy, then they’ll start sounding more dovish,” says Mr Tihanyi.

Either way, Mr Del Piero already may have cashed out before then. He is likely to play his last game for Sydney in August when the Sky Blues take on his former club Juventus.

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