Australian Dollar

The recent decline in spot iron ore prices is large by historical standards. At less than USD90/tonne presently, the spot iron ore price has fallen over 30% since June and is well below what had been considered its floor price of around USD120/tonne.

This is important as the Australian economy has found throughout the protracted financial crisis from its commodity sector.

Iron ore exports to China are key, and because the Chinese economy is itself slowing, demand for Australian produce is falling.

"The house view is that iron ore prices will rebound by early 2013 in line with a policy-led recovery in Chinese growth. The risk to this view, though, is that iron ore prices remain below the USD120/tonne marginal cost of Chinese production," says a note from ANZ Bank.

This risk is exacerbated by the sluggish Chinese policy response to date, although ANZ expects a more aggressive policy response once the Chinese leadership transition occurs over the next month or two.

Should the recent decline in iron ore prices and the Australian terms of trade be sustained, this would see weaker nominal GDP growth, weaker company profits, deterioration in federal and state budget positions and increasing financing challenges and delays for some mining projects under consideration.

ANZ Bank are, in light of the deteriorating situation facing Australia, forecasting 50 bps worth of interest rate cuts before the end of this year. An Australian dollar negative:

"The longer iron ore prices remain weak and the AUD remains strong, the less comfortable the RBA will likely be with the currency’s level, the greater the pressures for structural adjustment and the stronger will be the bias for more accommodative monetary policy.

"Given these risks and continuing declines in job advertising, ANZ is forecasting 50bps of official interest rate reductions by early 2013 as the RBA will be required to further boost the interest-rate-sensitive sectors of the economy. Beyond that time, the bias of rates still remains to the downside.

"Our FX strategists expect continuing bond inflows to mute the AUD’s normal balancing effect on the economy: absent this effect, the risks on the AUD would increasingly be to the downside."

Currency Services

custom charting