Christine St Anne: From spectacular highs the Australian dollar fell to its lowest in mid-May. To give us his views on the outlook for the Australian dollar, I'm joined by City Index's Peter Esho.
So, Peter, the Australian dollar started really high earlier this year, but fell to its lowest in May. Can you give us an insight into the main factors behind these movements?
Peter Esho: Our currency is very much tied to risk appetite and risk assets are very closely correlated with the way the Australian dollar moved against the U.S. dollar. Now, the Australian dollar had also run up against the euro to very high levels. It had a little bit more resilience there, but if we just take the swap against the U.S. dollar, for example, we saw a pullback in the copper price, we saw a pullback in the Chinese markets, the Shanghai Composite Index and we also saw a pullback in the Australian dollar.
So, those correlations were in play and every time there is risk aversion out there in the market, we see our currency fluctuating in line with those trends.
St Anne: Peter, do you expect further volatility to the Australian dollar? Will it get higher or remain lower?
Esho: Look, I think, one thing that was very well illustrated by the rise in the Australian dollar against the basket of all other currencies is the self-correcting mechanism that had to take place. I mean our currency appreciated very, very strongly in a short period of time and the economy started to feel the impact of a high currency. There has been a lot of talk around the carbon tax and the different types of drags on the Australian consumer, but the currency has been a huge disadvantage for Australia and we're feeling that at the moment, and that prompted the Central Bank to really move to ease - to stimulate demands.
So that self-correcting mechanism has put perhaps a ceiling, somewhat of a ceiling on the Australian dollar. The dollar can only rise so much until the economy starts to feel it and rates have to drop accordingly. So I think that $1.10 level was very important. It sent an indication that at that point the Australian economy starts to really feel the pain of the high currency, and therefore I think any test back towards those levels, we will start to see that pain really flowing back into the economy despite easing.
So I think those who call $1.20, $1.50, $1.70, really miss the point that a high currency is a huge disadvantage for the economy and really dents sentiment. So I think that's very important to watch and see how demand reverses, how the economy responds now that the currency has fallen off those highs.
St Anne: What about the impact on interest rates?
Esho: Look, the Reserve Bank held a very strong view that the Australian economy is in very strong shape and inflation was really a problem late last year. If you looked at Chinese inflation, it was running away and the Reserve held the stance that inflation really needs to move within that target range for them to respond. We actually saw inflation fall below the target range. That gave the Reserve Bank the mandate to move by 50 basis points.
So, I think inflation is very important. I think there will be inflationary pressures coming back into the economy as the currency falls, but I still think the currency can fall a little bit more and I still think the Reserve Bank is very focused on inflation. Inflation will drive where a rate policy goes and that's going to drive the currency to an extent. It's not completely an interest rate differential story with the Australian dollar.
It is also in risk aversion, risk appetite; and what we find ourselves at the moment is a currency war taking place between the Americans, the Japanese, for example, which is starting to feel the impact of a very strong yen and the Europeans, which you figured out, well, it's not in their interest for them to have a currency that's too strong. I think that's why we're seeing the euro fall back against the dollar. That's why we're seeing the Bank of Japan intervening, and I think that's why the Reserve Bank has finally woken up, come to the party and moved aggressively.
St Anne: So Peter, there has been a lot of discussion about the Australian dollar and its impact on the two-speed economy, is this impact actually just exaggerated?
Esho: Absolutely not. It's had a devastating impact. I mean you look at tourism; Australians are in a record numbers flying overseas, spending money overseas, and that's because Australia has become a very expensive tourist destination. If you look at the traffic numbers coming into Sydney Airport, for example, they're coming from places like Japan, Malaysia, China. You're not having the European travelers, the American travelers. You're having really the emerging travelers in the region coming to Australia.
Now, you need to start seeing a broader sample of people coming in for tourism, for example, and you don't get that with the cost disadvantage that Australia has with the high currency. The export sector, education is very important, and you've had a huge drop-off in Indian students, for example coming to Australia, because again it's just so expensive. That's fueled by the currency position.
So, I think the export economy has really been feeling the pressure. I think it's one thing that many commentators have missed in the Australian economy, that the Australian dollar has just risen too much and Australia has become too expensive as a destination to do business.
Manufacturing, we've been talking about it for a very long time. The car manufacturers needed a government injection. The steel manufacturers are struggling, they need government intervention. So absolutely across, particularly across the eastern seaboard, the services economy, the manufacturing economy has been hugely disadvantaged by the currency position.
St Anne: Peter, thanks for your insights.
Esho: Thanks for having me.