Australia's turn to enter the currency war?

A major casualty of China's slowdown (discussed here) has been one of its key natural resources supplier, Australia. Many Australians feel misled by all the projections of China's growing demand, believing that China will continue beating its yearly 8% growth projections.

The Australian: - China outperformed for a decade its own government's 8 per cent growth target, which was lowered to 7.5 per cent for last year and this year.

And Australia's budget planners were confident China's economy would keep surpassing the official target.

They forecast that China's economic growth, the core driver for Australian commodity sales and thus of our formerly burgeoning terms of trade, would bottom out at 8.5 per cent last year, rebounding higher this year. The current budget also was based on 2012 growth reaching 6.25 per cent in India and 2.25 per cent in Japan.

But China's growth for last year ended up at 7.8 per cent, India's at 4.5 per cent and Japan's at 2 per cent. The forecasts were thus overestimated by 8.3 per cent, 28.1 per cent and 8.9 per cent respectively.

China is Australia's top export buyer, Japan the second and India the fourth. So these outcomes had a big impact on budgeted receipts.

Last year's budget papers forecast "economic conditions in China to remain solid", and that Australian resource companies, high-end manufacturers, service providers and rural commodity producers would all gain more opportunities "as the Asian Century proceeds", brandishing the government's mantra of the day. They insisted that "China has the capacity to use macro-economic policy to stimulate growth", and that terms of trade would remain "close to their highest sustained levels in 140 years".

Right... So much for the "Asian Century" - at least for now. The deterioration in Australia's fundamentals has been harsh, as exports and new orders plunged in the last few months.

Australian Industry Group: - Reflecting ongoing weakness in the global economy and the high Australian dollar, the manufacturing exports sub-index worsened again in April. The exports sub-index fell 2.9 points to 24.5 (seasonally adjusted) in April, marking the ninth consecutive month of contraction and the lowest reading for the exports sub-index in the history of this series (commencing in 2004) .

Manufacturing PMI Sub-indices (source: Australian Industry Group)

And Australia's overall manufacturing index hit the lowest level since 2009, with the nation's manufacturing sector in full contraction.

Source: DB

The Reserve Bank of Australia has been holding rates steady for much too long, believing in some sort of miracle from China (per government's forecast). What makes their job particularly difficult is the fact that both the US and Japan are conducting unprecedented monetary expansion, thus putting upward pressure on the Australian dollar. And that makes Australian products less competitive in global markets, particularly versus South American competitors (see post).

The Australian: - [Matthew Johnson (UBS)] said any further easing in the US would force the RBA to cut interest rates to stop the [Australian] dollar from being propelled higher. 

Now the RBA has little choice but to ease monetary policy by lowering short term rates. Given the worsening economic fundamentals and most major central banks' highly accommodative policies, the RBA will be forced to abandon its normally hawkish stance. It may be Australia's turn to enter the currency war.

SoberLook.com

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