What a Shifting Exchange Rate Means for the Domestic Economy

Over the past few years, the Australian dollar (AUD) has traded at or near parity with the US dollar (USD). While a strong currency may be viewed positively, for example as a result of a strong economy, an overvalued currency can also create headwinds for that same economy. In Australia, a strong AUD has had several negative consequences for the Australian economy, namely:   

1. a stronger purchasing power that results in consumers spending more of their money overseas through travel and internet spending; and 
2. a reduction in profitability for companies absorbing lower revenues on offshore transactions, i.e. imports and exports.  

When we talk about the Australian dollar's strength or weakness we are mostly comparing it relative to the USD. As the chart below demonstrates, the AUD has weakened significantly against the USD in recent months.

However, Australia's trading partners are not just confined to the United States, nor are transactions carried out solely in USD. Therefore, it is also important to look at how the AUD performs against a basket of currencies that Australia trades with. It can be useful to also compare how the AUD has performed relative to other currencies against the USD. This can be done by examining the Australian dollar Trade Weighted Index (TWI). The TWI is based on a weighted average of a basket of currencies chosen that account for at least 90% of Australia's goods and services trade. The TWI can be seen in the chart; moreover, we can see the significant fall in this index which reflects the Australian dollar weakening relative to this trade weighted basket of currencies.

This change, coupled with the fall in the AUD/USD exchange rate, should have an overall positive effect on the Australian economy, for both business and retail sectors.

Some of the benefits a lower AUD will provide to the economy include:

• For businesses, the effect of translating overseas profits will provide an automatic boost to earnings - 35% of the ASX200 companies' earnings are offshore or USD denominated*
• A weaker currency will also lead to improved product competiveness abroad - in a global market, a weaker AUD results in domestic price competitiveness improving, i.e. Australian manufactured goods and services become cheaper relative to their international counterparts
• Consumer spending may be redirected from offshore purchases to within Australia. A weaker AUD should provide a windfall to the Australian economy via consumer spending. As we start to see domestic prices become relatively less expensive to their overseas counterparts, Australian consumers may choose to spend more money on Australian goods and services
• Higher domestic spending, resulting in an increase in job growth
• Increased tourism to Australia - tourism is a significant contributor to Australian GDP, and so the effect of Australia being cheaper to travel through should not be forgotten. This can also lead to jobs growth. 

Weekly Indices:

The Australian All Ordinaries Index has moved down decreasing by -0.1% since closing last Friday to 01:10 pm today. 

 

The rest of the world as measured by the MSCI index increased +1.0% in A$ from closing last Friday to end of trade Thursday.

Have a good weekend,

The team at IPS