Ben Jarman, economist at JP Morgan, holds a similar view to Commonwealth Bank’s currency strategy team, and doesn’t think the Australian dollar is overvalued in real trade-weighted terms.
Despite its recent rally, Jarman agrees that a recent recovery in commodity prices leaves it close to fair value.
However, as the Reserve Bank of Australia (RBA) has been warning over the past year, Jarman says the Australian dollar is now “complicating” the outlook for Australia’s economic transition, noting that it is now at a level that will create headwinds for both inflation and GDP growth should its strength persist.
Here’s a snippet from a report he released today explaining why:
We think the exchange rate is becoming a problem for both inflation and growth. Consumer goods import prices were very weak in yesterday’s CPI data, and on the detail today, that weak momentum in imports should carry through to more CPI headwinds, particularly feeding in AUD appreciation in Q3. The TWI [trade-weighted index] at current levels is also no longer likely to be supporting services exports, which had previously been adding around 0.5 percentage points to growth per year.
This chart from Jarman puts those concerns in the visual form.
It shows the rolling annual contribution of Australian services exports to real GDP growth compared to movements in the Australian dollar TWI. Jarman has flipped the axis for the latter to show the relationship between the two.
Should the pattern be maintained, it suggests that instead of assisting services exports, the recent strength in the Aussie will act as a headwind to services exports, potentially weighing on economic growth.
And, as Jarman pointed out, the appreciation in the Aussie carries the potential to weaken import prices, and with it broader inflationary pressures.
While that may be seen as a welcome outcome to some given it could mean cheaper prices, persistently weak inflationary pressures will do little to help spur wage pressures and, as a result, debt serviceability for households.
“A stabilising terms of trade has made the RBA less nervous about the exchange rate, but headwinds to goods inflation and GDP growth from the TWI are nevertheless building,” says Jarman.