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Strong AUD Dampens Export Recovery for Australian Industries

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by William Chapman
Sep 14 2020

As the COVID-19 pandemic continues to grip the global economy, the Australian dollar (AUD) has recorded a significant reversal of fortune over the past six months. After falling to a 10-year low of US$0.57 at the height of the initial financial panic in March 2020, the AUD has since recovered, reaching a two-year high of US$0.74 at the beginning of September.

‘Two trends underlie the AUD’s sudden strength: a weakening US dollar and strong demand for Australian commodities. The newfound strength of the AUD has significant implications for Australia’s economic recovery from its first recession in nearly 30 years,’ said Senior Industry Analyst Will Chapman.

Mining drives AUD higher

Strong demand for Australian commodities, particularly iron ore and gold, has been a significant contributor to the AUD’s strength in recent months. Stimulus measures in China designed to boost construction activity have supported a rise in demand for iron ore, which has increased prices to US$128 per tonne in September, the highest level since 2014. The price of gold has risen by close to 30% in 2020, reaching a historic high of US$2070 per ounce in August.

Surging demand for Australian mining commodities has supported demand for the AUD, lifting its value on exchange markets. Several major players in Australia’s Iron Ore Mining and Gold Ore Mining industries, such as Fortescue Metals and Newcrest Mining, have recorded surging profitability in 2019-20.  

‘Despite the strong performance of iron ore and gold prices, the Australian dollar’s appreciation has partly offset the benefits to local miners. As global commodity prices are set in US dollars, the strength of the AUD has exerted downward pressure on the revenue that Australian miners receive per unit of production,’ said Mr Chapman.

AUD strength hinders recovery from COVID-19

The strength of the AUD is expected to negatively affect export-focused industries outside the mining sector, as exports become more expensive and less competitive in foreign-currency terms. Weaker export competitiveness is likely to hinder agricultural industries such as the Grain Growing industry, where exports are expected to account for 57.5% of revenue in 2020-21. Grain growing revenue is anticipated to rebound by 19.9% in 2020-21, following a decline of 17.6% in 2019-20. Other export-oriented agricultural industries at risk include Fishing and Milk Powder Manufacturing.

The strength of the AUD is also expected to reduce the cost of imported products, providing an additional setback to industries facing rising import penetration, such as Toy and Sporting Good Manufacturing, Footwear Manufacturing, and Cosmetics, Perfume, and Toiletries Manufacturing. Imports accounted for over 80% of domestic demand in each of these industries in 2019-20.

Beneficiaries of the stronger AUD

The recent strength of the Australian dollar is expected to benefit industries that heavily rely on imported products as inputs. In particular, the Computer and Software Retailing and Clothing Retailing industries will likely benefit from higher profit margins as the stronger AUD makes imports more affordable, reducing purchase costs.

‘While the strong AUD has reduced purchase expenses for many firms, weak economic conditions have pressured these businesses to pass on cost savings to consumers through lower prices. Consumer sentiment has plunged in the wake of the COVID-19 pandemic, and is expected to remain negative through to 2022-23. As a result, consumers have become more price-conscious, driving retailers to lower prices to remain competitive,’ said Mr Chapman.

Cash rate floor may support AUD

Monetary policy settings in other global economies have also boosted the Australian dollar’s strength. Several central banks, including those in the United Kingdom and New Zealand, have flagged the possibility of introducing negative interest rates to stimulate investment and economic activity. In contrast, the RBA has signalled that it does not plan to reduce the cash rate any further than its current setting of 0.25%, making Australian government debt and other related securities comparatively more attractive to global investors.

Recovery outlook

The AUD’s strength has significant implications for Australia’s economic recovery from the recession attributable to the COVID-19 pandemic. The Australian dollar is expected to appreciate at an annualised 1.7% over the next five years, to reach an average annual value of US$0.72 in 2025-26. The persistent strength of the AUD is likely to constrain export growth and make the recovery from COVID-19 more dependent on domestic consumption. Australian GDP is expected to grow at a compound annual rate of 2.9% over the five years through 2025-26, to $2.11 trillion.

‘Given the RBA’s limited scope to weaken the currency through looser monetary policy, the Federal Government will likely need to increase its focus on stimulating domestic consumption to drive economic recovery. Betting on an export-led recovery carries some risk as the AUD’s value is largely out of our control,’ said Mr Chapman.

IBISWorld reports used to develop this release:

 

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Jason Aravanis
Strategic Media Advisor – IBISWorld Pty Ltd
Tel: 03 9906 3647
Email: mediarelations@ibisworld.com