Overvalued Aussie Dollar the Biggest Threat to Economy

By Kristie Kwok on 18 Dec 2013
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According to the latest IMF findings, the biggest threat to the Australian economy in the near future is the strong Aussie dollar

The level of exchange rate is difficult to control because it is determined by both local factors and influences outside the Australian economy.

Theoretically, direct intervention from the Reserve Bank of Australia (RBA) through interest rate cuts could weaken the Australian currency; however, such an action could also destabilise the housing market by fuelling further house price increases. 

Strong Aussie Dollar Hurts Non-Mining Sectors

Australia’s currency appreciated almost 50 per cent in the last four years. The IMF estimates that it is overvalued by 10 per cent. 

A strong currency hurts the demand for non-mining exports because foreign buyers have to pay more for Australian goods and services.  

“The RBA is still concerned about the high value of the Australian dollar.”

This makes our prices less competitive compared with other countries. Manufacturing, tourism and agricultural industries all suffer with a strong Aussie dollar.

The IMF warns that if our currency does not weaken to reflect underlying fundamentals, it could eventually lead to a reduced demand for labour, slower wage and employment growth, a decline in consumption growth and weaker government finances.

Lower Interest Rates Support Housing Construction but Dollar Remains High

Interest rate cuts normally lead to lower currency values. However, despite rate reductions since the end of 2011, the RBA is still concerned about the high value of the Australian dollar. 

In a recent statement, Glenn Stevens reiterated that a lower exchange rate is likely to be needed to achieve balanced growth in the economy. 

As mining investment is expected to drop off over the next few years, it has been increasingly important to stimulate growth in non-mining industries for the overall development of the Australian economy.

To this end, interest rate cuts have been effective to stimulate demand and supply in housing construction. However, as the IMF states, housing construction alone is unlikely to be sufficient to lift non-mining sectors. 

Further Rate Cuts Could Weaken Currency but Fuel House Prices

Although further interest rate cuts could bring down our overvalued currency, it can also potentially lead to more house price increases.  

Both the OECD and IMF have already expressed concerns about the growth of Australian property prices, with the IMF stating that a price overshoot could reduce consumer confidence and impact overall economic activity. 

“Although further interest rate cuts could bring down our overvalued currency, it can also potentially lead to more house price increases.”

Given the risk to the property market, it seems more likely that the RBA will rely on external influences rather than use interest rates to overcome the currency issue. 

Leaving our Currency Problem in the Hands of the Feds

As China’s economic growth has strengthened our currency further, the biggest hope for currency depreciation now lies in the hands of the Feds. 

Strong US economic data will support the case to taper quantitative easing, which should result in the appreciation of the US dollar against our currency.

About the Author

Kristie Kwok is a Street News writer and a fully qualified chartered accountant with a Bachelor of Accounting and Finance degree. Kristie has a passion for all aspects related to property. She also has a strong interest in the economy and financial markets. Kristie has worked for reputable corporates such as KPMG UK, UBS, Lloyds Banking Group and the Royal Bank of Scotland.

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