Australian dollar - review of the year

[John From Moneycorp]

Hi all – as we approach the end of 2012, we have written a review below on the Australian dollar - thanks

 

 

The Australian dollar is still overvalued. In his December monetary policy statement Reserve Bank of Australia (RBA) Governor Glenn Stevens bemoaned the situation, saying; "the exchange rate remains higher than might have been expected". However, the overvaluation is less than it was a year ago. Although it is impossible to be precise about such things, the consensus is that the dollar is about 10% too high. At the end of 2011 that number was more like 15%.

 

In the last year and a half the sterling/Aussie exchange rate has gone nowhere. Over the last 12 months the pound has been stuck mainly between $1.48 and $1.58, only rarely venturing outside that channel. In February it looked for a moment as though the AUD was gearing up for another great leap forward but the following three months saw it fall by 10%. In all there were four significant changes of direction during 2012 yet in mid-December sterling was unchanged against the Aussie from its position 12 months earlier.

 

That lack of net movement is not as unusual as it might appear. The pound is also unchanged from its levels a year ago against the Swedish and Norwegian crowns and the Canadian dollar. Against the US dollar sterling has strengthened by 2.5% over the year and against the euro by 4.5%. Even those are relatively modest shifts when viewed against the background of history.

 

Lower commodity prices are partly to blame for the Australian dollar's stalled progress. The price of iron ore peaked in February 2011 and has since fallen by 40% in AUD terms. Australian interest rates have also played a part. For most of last year the RBA held its benchmark Cash Rate at 4.75%. It lowered that to 4.5% last November and reduced it further this year. The most recent cut, in December, left the Cash Rate at 3%. Although analysts do not expect any further reduction, 3% is the lowest Australian benchmark interest rate in half a century.

 

Investors also have issues with Australia's domestic economy. New home sales have fallen steadily in the last couple of years and house prices have stalled. Business confidence is weak. Retail sales are flat.

 

But the economy is still growing. It expanded by 0.5% in the third quarter of 2012 and by 3.1% in the 12 months to September. Australia also still has the best possible credit rating. It is one of only a dozen countries to retain a full hand of AAA ratings. Couple that with interest rates based on a 3% benchmark, the highest in the developed world, and the Australian dollar is by no means unattractive to investors.

 

Whether that attraction will be enough to send it higher in 2013 is a different question. The Aussie's performance against the pound next year could depend more on what goes on in Britain than on what happens in Oz. If the UK economy can get back into expansion mode sterling could move higher. But if Britain cannot relax its grip on recession it is hard to argue against a stronger Australian dollar, overvalued or not.