A Weak Currency Has Helped Australia

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What's going on?

Data on the Australian economy came out this week – and it’s doing better than expected: it grew at an annualized rate of 3% in the fourth quarter of 2015. A slowing China has hurt Australia in recent years, but it appears to be rebounding. And how it’s doing so can teach the rest of us a thing or two about how economics works.

What does this mean?

As its economy slowed over the past few years, Australia’s currency has declined significantly versus global peers (it’s down 30% versus the US dollar, for example). It’s normal for the value of a country’s currency to fall when its economy slows down: international investors don’t expect to make as much money in a slowing economy and therefore move elsewhere. However, the resulting lower currency makes it easier for a country to sell things abroad and, consequently, get back on its feet: Australia has been exporting more “services”, like insurance, and its manufacturing sector is expanding at levels not seen in more than 5 years.

Why should I care?

The bigger picture: This shows how a big currency devaluation can help a struggling country. It’s basically like a built-in stabilization mechanism: economy struggles, currency weakens, it becomes easier to sell goods abroad. But it’s not without downsides: inflation (rising prices) typically increases because the currency is worth less in international terms (one Australian dollar buys fewer kiwis from New Zealand, for example). Therefore, people’s incomes can’t buy as many imported goods (and a lot is imported these days). But a “cheap” currency does help the economy as a whole recover.

For markets: Australia’s currency went up on the news. Since the economy was stronger than expected, investors deemed it less likely that Australia’s central bank would try to stimulate the economy by cutting interest rates. Remember, all things being equal, international investors prefer to invest in countries that pay higher interest rates. And so, when news makes it less likely that Australia’s interest rate will go down, its currency goes up.

 

 

Originally posted as part of the Finimize daily email.

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