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Australian dollar strength poses a 'serious threat' to economic growth: Capital Economics

The Australian dollar's current strength could shave about 1 percentage point off growth, according to Capital Economics, as non-resources exports lose their competitive edge.

Chief economist for Australia Paul Dales says that even the Aussie's current level "poses a serious threat to the economic outlook". 

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The local unit jumped about 1 per cent overnight, to US74.85¢, after the price of iron ore leapt a record 18.6 per cent to $US63.74 a metric tonne. It later eased on worse-than-expected Chinese trade data.

The initial surge, on speculation about Chinese steel production, wrong-footed a range of analysts, who said the metal's recent rally would soon run out of steam.

The Aussie dollar, too, was expected to ease once iron ore turned down.

However, the commodity's continued recovery, along with surprisingly strong growth in fourth-quarter gross domestic product last year, low global interest rates and doubts about the pace of the US Federal Reserve's nascent monetary tightening have converged to push the Aussie to eight-month highs.


A gathering chorus of economists say the Reserve Bank of Australia could soon resume talking down the currency, or even consider its first cut in the cash rate since May last year.

However, current market pricing has pushed back bets on such a reduction to next February.

Goldman Sachs Asset Management's head of fixed income for Asia-Pacific Philip Moffitt last year predicted the current bounce in the Aussie to US75¢, based mainly on bets the Fed would be slow to lift rates.

Despite Australia's strong fourth-quarter GDP data, he is also still forecasting another cash rate cut this year.

"The market response to the GDP was, 'oh, rate cuts are now off the table'," he said on Tuesday.

"I don't think that's right at all.

"We're getting to the point – let's call it US75¢ – where you have to start looking for the RBA to start mentioning the currency again, and that will be the first step towards the next rate cut."

Mr Dales agrees a higher dollar could set back the readjustment of the Australian economy towards a wider range of non-resources exports.

"The level of the currency is a big deal for an open economy like Australia and is especially important at the moment for two reasons," he said.

"First, with interest rates at a record low, a weaker exchange rate is arguably a more effective way to boost economic growth and inflation than further interest rate cuts.

"Second, the 25 per cent weakening in the dollar on a trade-weighted basis since 2013 has played a large role in supporting GDP growth."

He calculates that the Aussie's decline, in line with commodity price falls, since 2013 has added an average 0.7 percentage points to annual growth in GDP.  

Non-resource net exports – after subtracting imports – accounted for 0.9 percentage points of Australia's surprise fourth-quarter surge in GDP, to 3 per cent year-on-year.

All this could be undone, however, if the Aussie continued to firm, although the improvement in national income from the higher iron ore price would help offset the hit to non-resource exports.

"If other things remained the same, the annual rate of GDP growth would fall from 3 per cent at the end of last year to just 1 per cent by the end of this year," Mr Dales said.