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Is a stronger Australian dollar welcomed?

Is a stronger Australian dollar welcomed?

The Australian dollar has strengthened more than 5% this year, making it the sixth best-performing currency against the US dollar, according to Bloomberg data. But is a stronger AUD welcomed?

The Australian dollar is currently trading above US77 cents, up in value against the US dollar by more than 5% from the end of last year, and 12% higher than its January low. Its slow but steady rise is prompting a mixed response. 

Why has the Aussie dollar risen?

Some of the factors that drive the AUD higher can include better-than-expected economic growth in the country, fewer interest rate increases by the US Federal Reserve, and the possibility that prices of commodities, Australia’s largest export, could be bottoming.

Against this backdrop, currency analysts at Commonwealth Bank have raised their year-end AUD forecast to US78 cents from US70 cents.

So what does this all mean?

For consumers

From an individual consumer’s point of view, a stronger AUD means it can cost less to travel abroad and shop locally for imported goods.

The value of your dollar is stretched. For example, $1,000 could buy you about US$766 now compared to US$686 in January when the AUD was weaker against the greenback, excluding any commission or additional costs.

An individual's spending power also improves when prices of everyday necessities such as fuel come down when converted to AUD. This essentially means consumers have more disposable income.

For people from overseas working in Australia, a higher Aussie is often good news too as the amount of AUD they have to spend to convert to the same amount of foreign currency goes down.

For businesses

The impact of a stronger AUD on businesses is mixed, depending on how they generate their income.

For companies importing goods and raw materials from overseas, a higher AUD will theoretically help them cut costs and improve profit margins because the same dollar can buy more now than it could before.

By contrast, exporters who generate revenue from offshore can face significant headwinds when the AUD appreciates. They may receive lower revenue when translating the foreign currencies back to the AUD. Further, their AUD-denominated goods may become pricier for foreign buyers, which can impact demand.

That said, the current AUD level may not necessarily be bad for exporters, as there is debate about exactly at what level the currency would hamper growth.

In a report, Commonwealth Bank chief economist Michael Blythe argued the threshold level for AUD to cause “economic pain” could be higher than many would expect.

“The number of exporters doesn’t normally vary much from year to year. But there was a significant spike up in the number of companies exporting in 2013-14," he said. "The spike is all the more interesting because it occurred at a time when the AUD was still high. The AUD averaged US92 cents in 2013-14.

“The export response suggests the AUD was not as big a restraint on the economy that policy makers feared.” 

“Business surveys are sending positive signals on the export front. Non-resource exports may continue to surprise on the upside in 2016,” Blythe added.

Impact on property prices

In terms of the real estate market, properties in Australia can become more expensive for overseas buyers if their currencies weaken against the AUD, which may in turn deter demand from certain segments of the market.

However, the exchange rate is clearly not the only element in the property buying equation. Australia’s official cash rate, which is a benchmark for other interest rates in the country, has been at a historic low for a prolonged period.

In April, the Reserve Bank of Australia (RBA) said low interest rates are supporting demand, but that it remained a focus for the central bank to contain risks in the housing market by ensuring strong lending standards.

Factors such as population growth, construction activities and property supplies also all contribute to house price movements.

Impact on the economy

The RBA has been vocal about advocating a lower AUD – a target of around US65 cents – to support the nation’s economic expansion. 

“A lower AUD is an important driver of the transition from mining to non-mining led growth. So not surprisingly the stronger currency has fed straight into the interest-rate debate,” said Blythe.

“The RBA’s own research concludes a 10% AUD appreciation will reduce GDP [gross domestic product] growth by 0.5-1 percentage point over two years,” Blythe said.

As noted by the RBA governor, Glenn Stevens, on March 22: “Unless you think that the commodity price trend now is different and we are headed back to a world of considerably higher prices for an extended period... it’s not clear that that situation will warrant a much higher exchange rate than this and there is some risk actually that the currency might be getting a bit ahead of itself.”

The AUD traded as high as US76.27 cents on March 21, the day before Stevens made that comment.

However, it is important to note that “the governor did not suggest that the Aussie dollar was markedly over-valued”, CommSec chief economist Craig James wrote in a research note on March 22.

“Rather, similar to [deputy governor] Philip Lowe, the suggestion is that it would be helpful if the Aussie dollar was a little lower,” James said.

This article is intended to provide general information of an educational nature only. It does not have regard to the financial situation or needs of any reader and must not be relied upon as financial product advice. Past performance is not a reliable indicator of future performance.