Here's Why Glenn Stevens Could Cut Rates Further

Getty/Ian Walton

The Australian economy is in transition from the terms of trade and mining investment-related boom that kept growth strong through the dark days of the GFC, to something more evenly spread across the economy and domestically focussed.

It’s a transition that has lead to hitherto unprecedented verbal intervention by the RBA Governor last month, when he picked 85 cents as a reasonable level for the Aussie to be trading at.

His actions, along with the general improvement in other developed markets has seen the Aussie fall from around 97 cents in October last year to a 3 year low of 0.8756 yesterday morning.

Why the RBA has been so keen to see the Aussie dollar fall is evident in a research paper released today by central bank titled “Macroeconomic Consequences of Terms of Trade Episodes, Past and Present” in which the authors succinctly sum up the problem that a strong dollar — at the same time the terms of trade boom has ended — poses to the economy.

The terms of trade peak has passed

The paper notes:

downswings in the terms of trade have typically coincided with two years of below-average per capita GDP growth; an increase in the unemployment rate and other adverse macroeconomic outcomes. Typically, GDP per capita returns to its trend rate of growth by five years after the peak in the terms of trade.

Australia is currently in the downswing phase – terms of trade detracting from growth

The authors conclusion mirrors what the Governor himself might have written:

“Consequently, the expected easing in the terms of trade, reflecting growth in the global supply of the bulk commodities, may be accompanied by falls in the real exchange rate. More generally, an increase in Australia‚Äôs competitiveness would help facilitate the macroeconomic adjustments necessary during the transition from the investment to production phase by providing support to sectors outside of the resources sector, thereby helping to rebalance growth in the economy.”

The full paper is worth a read and can be found here

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