Aussie Dollar Decouples to Race to Highs

Australians are leaving their country in large numbers. Over the past year, a record 7.6 million local resident have left the country on short-term trips, HSBC says, as they take advantage of the strength of the Australian dollar to travel abroad.

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Australians planning to visit London for this summer’s Olympic Games will get bang for their buck. The Aussie, which recently hit a 27-year high of 67.96p against sterling, has appreciated by more than 80 percent since Sydney hosted the Olympics in 2000.

The Australian currency is not just setting records against the pound. After a strong start to the year, the Aussie is trading at close to a record high against the euro, homing in on last year’s highs versus the US dollar and, on a trade-weighted basis, stands just below the 20-year high reached at the height of last year’s commodity price frenzy, according to RBS.

But will this be as good as its gets for the currency? Certainly, there are reasons to think that the dollar has got ahead of itself in recent weeks.

Over the past month, the Australian dollar has decoupled from persistent worries surrounding the eurozone, says Adarsh Sinha of Merrill Lynch. “This has starkly manifested itself in the decline of euro/Aussie to record lows,” he says. “The combination of more aggressive ECB measures and the improvement in global economic data has raised hopes that the financial and economic contagion of the euro-area crisis to the rest of the world could be more limited than previously assumed.”

But, even accounting for the improved sentiment on the eurozone, Mr Sinha says the Aussie is trading at levels that are at odds with underlying economic forces.

These forces are China and a more uncertain outlook for global economic growth. More than 70 percent of Australia’s exports go to Asia. About half go to China and Japan, according to HSBC.

Paul Bloxham, chief economist for Australia and New Zealand Bank, says growth in Australia’s large trading partners is expected to ease to 3.2 percent in early 2012 from 4.6 per cent in 2011. As such, the Aussie could depreciate from Wednesday’s level of almost $1.05 against the US dollar to $0.95 by the end of 2012.

John Horner, foreign exchange strategist at Deutsche Bank in Sydney, has a similar view. While he does not believe China will experience a hard landing, the fact that commodity prices look to have peaked means that the Aussie will find it difficult to hold its current level against the US dollar.

Merrill Lynch estimates that Australia’s terms of trade will fall by 5.5 percent, largely because of the decline in commodity prices in the second half of 2011.

Few economists expect the Aussie to depreciate significantly, however, and do not see it trading anywhere near its $0.75 average against the US dollar since floating in 1983. For that to happen, they say, there would have to be a deep shock to the world economy that triggers a sharp fall in commodity prices.

In the absence of that, the Aussie is well underpinned in the mid $0.90s even if, as the market expects, the Reserve Bank of Australia cuts the official cash rate by 50 basis points to 3.75 per cent by the middle of the year. This is because the Aussie will retain a significant yield advantage over Group of 10 nation currencies and Australia is one of a dwindling number of countries that still boasts a triple A credit rating.

Indeed, recent figures from the RBA show foreign ownership of Australian government bonds rising to more than 80 per cent. According to Richard Grace, chief currency strategist at Commonwealth Bank of Australia, much of that demand is from central banks and sovereign wealth funds looking to diversify out of other currencies such as the euro.

Moreover, Australia is in the middle of the biggest mining boom in its history. Mining investments are expected to amount to a huge 7 percent of gross domestic product over the next couple of years.

There is a downside to a persistently strong Aussie: the impact on sectors such as manufacturing, tourism and education.

Toyota blamed the Aussie when it axed 350 jobs at its Melbourne plant this week. But, says Mr Bloxham, the strong dollar has allowed the country to absorb the biggest commodities boom in a century without excessive inflation. It has helped keep import prices down. By putting pressure on industries exposed to external trade, it has also made room for the mining sector.