The Australian dollar took a move upwards on seemingly bad news. Investment in capital goods was down.
The reason why the dollar got stronger was that investment in the manufacturing sector was up. An unexpected event. This is seen as good as Australia tries to get over dependence on the mining boom.
Not that long ago it was fashionable to talk about a 'two speed economy'. The mining sector forged ahead, driving overall GDP growth, while manufacturing shrank. It was more accurate to describe a 'multi-speed' or 'patchwork' economy as different states and industries met very different fortunes.
So this is good news of sorts, but still points to an overall downward trend in Investment (a component of Aggregate Demand).
The story does help us understand important influences on the exchange rate. To understand why the exchange rate changes on this news is important:
1. The exchange rate is determined by the demand for and supply of the Australian dollar.
2. A major reason to demand Australian dollars is to buy iron ore (Australia's largest export) and the price of iron ore has fallen 28% in the last year. Therefore buyers need fewer dollars and so demand for dollars falls.
3. Another reason to buy dollars is to invest in Australian businesses. If an economy is growing strongly the chance making a profit is higher.
4. The new figures on investment in manufacturing imply that Australia will grow faster than was previously expected.
5. Therefore confidence in Australian future profits has risen, this will mean greater demand for investing in Australia in the future, and so the demand for dollars rises now.
6. Demand for Australian dollars rises now because some speculators will expect the dollar to be worth more in the future and they seek to buy dollars now to make a profit reselling them later.
It's easier on a diagram!
Showing posts with label Two speed economy. Show all posts
Showing posts with label Two speed economy. Show all posts
Thursday, 29 May 2014
Monday, 4 November 2013
Cash rate on hold, but a war of words on the exchange rate
The RBA kept the cash rate on hold today. This was expected, despite the latest inflation rate figures being slightly higher than expected.
The RBA have tended to over react to inflation figures in the last eighteen months, which is odd because they know interest rates take up to two years to affect the headline inflation rate. On this occasion other considerations may have outweighed inflation concerns.
The RBA are worried about the future growth of the economy. The mining sector is investing less and the fall in commodity prices means that export values are falling. Together that means lower Aggregate Demand and so lower inflationary pressure in the medium term.
The non-mining sector has to provide the growth which is necessary to maintain employment. A key issue for the non-mining economy is the exchange rate. The resources boom pushed the exchange rate up, made imports cheaper and exports more expensive for foreigners.
Now the exchange rate needs to fall to help the non-mining sector grow. Imports will be less competitive and exports cheaper allowing a boost to Aggregate Demand (assuming the Marshall-Lerner conditions hold).
The RBA could lower interest rates to help make the $Aus less attractive to hold (as relative exchange rates abroad stay the same). Instead they have opted to 'talk down' the $Aus in order to achieve the lower exchange rate. They clearly indicate that a lower interest rate will be set next year, which should lead to a fall in the exchange rate. But now the $Aus should fall on the expectation of this change. Why hold Australian dollars until they fall in value when you can sell now?
So the RBA can eat their cake and have it. They maintain anti-inflationary pressure by not lowering interest rates and get a a lower exchange rate to help boost growth. Let's hope it works.
The RBA have tended to over react to inflation figures in the last eighteen months, which is odd because they know interest rates take up to two years to affect the headline inflation rate. On this occasion other considerations may have outweighed inflation concerns.
The RBA are worried about the future growth of the economy. The mining sector is investing less and the fall in commodity prices means that export values are falling. Together that means lower Aggregate Demand and so lower inflationary pressure in the medium term.
The non-mining sector has to provide the growth which is necessary to maintain employment. A key issue for the non-mining economy is the exchange rate. The resources boom pushed the exchange rate up, made imports cheaper and exports more expensive for foreigners.
Now the exchange rate needs to fall to help the non-mining sector grow. Imports will be less competitive and exports cheaper allowing a boost to Aggregate Demand (assuming the Marshall-Lerner conditions hold).
The RBA could lower interest rates to help make the $Aus less attractive to hold (as relative exchange rates abroad stay the same). Instead they have opted to 'talk down' the $Aus in order to achieve the lower exchange rate. They clearly indicate that a lower interest rate will be set next year, which should lead to a fall in the exchange rate. But now the $Aus should fall on the expectation of this change. Why hold Australian dollars until they fall in value when you can sell now?
So the RBA can eat their cake and have it. They maintain anti-inflationary pressure by not lowering interest rates and get a a lower exchange rate to help boost growth. Let's hope it works.
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