Since the last article, the RBA has made the decision to hike the cash rate again. Whilst this comes as no surprise to many economists, it has had some surprising implications. The AUD has experienced an appreciation, albeit minor, for the first time in a while. Whilst many would assume that this would negatively impact export competitiveness, Australia’s exports are reaching new heights as the narrow export base takes over and commodities begin to make up the majority of exports moving out of Australia. This fortnight’s article will analyse the nature of China and Australia’s trade, as well as the implications of the recent cash rate hike on the exchange rate, with a broader focus on the external stability of Australia’s economy.
China’s sudden export growth and the future of trade for Australia
Following a two-month lockdown in major cities, China experienced significant economic growth as lockdown measures eased and exports boomed. Immediately after China’s economy reopened in early June, China saw a 17.9% increase in exports. In July, China beat expectations and saw an 18% increase in exports. David Chao, a market strategist at Invesco, argues that the easing of lockdown measures allowed production activity to return to normal in major cities and key provinces, like Zhejiang. Higher production obviously translates to more competitive exports, as growing supply pulls down prices and makes Chinese exports more affordable for the rest of the world.
Despite this, China’s imports only grew by 2.3% as domestic demand for overseas goods fails to meet expectations and fails to reach its pre-COVID level. Specifically, Chinese imports of machinery and hi-tech goods fell dramatically, falling from 20% growth year-on-year in early 2021 to negative growth year-on-year in July 2022. Thus, whilst strong export growth typically signals a strong, sustainable economy, this may not be the case for China. The lack of domestic demand suggests that China is suffering from a significant economic slowdown within its own borders, which may translate to a slowdown for other economies.
This is further corroborated by a Bloomberg article, which shows that Germany and South Korea - major exporters of manufactured goods - have recorded deficits with China due to their unusually low demand. However, Australia has proven to be resilient in the face of the Chinese slowdown, with Craig Brown, a corporate finance executive at Petra Capital, arguing that Australia’s exports are reaching new heights. Notably, total export income for Australia hit an all-time high of $581bn, beating the previous record by 28%. Even though Australia is projected to achieve a current account deficit in the next few years, this should provide a much-needed boost to the BOGS balance.
In terms of export composition, Australia’s exports of iron ore, coal and gas (LNG) are leading the way and driving most of this strong export growth. Despite only making up 30% of total exports in 2020, the aforementioned exports now account for 70% of the total value of goods exported out of Australia. This shows that not only is Australia taking advantage of its specialisation in commodities and its hefty resource endowments, but other nations are as well. Japan and China are said to import 41% and 38% of our LNG exports respectively, as both nations push towards more sustainable sources of energy.
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The cash rate changed…. Again…? How will this impact the exchange rate?
Yeah, that’s right. It changed. Again. No surprises here. Last week, the RBA made the decision to lift the cash rate by 50 basis points to 1.85%. This was not an unexpected rate hike. As mentioned in last fortnight’s article, many economists tipped the .50% rate hike amidst rising inflation levels and below-NAIRU unemployment levels. Whilst this decision will undoubtedly increase the cost of living and increase monthly mortgage repayments, it’s also important to consider how this decision may influence Australia’s external stability.
Usually, when the cash rate increases, the exchange rate channel of the transmission mechanism tells us that a higher cash rate leads to an appreciation of the AUD. This is because a higher cash rate translates to rising interest rates, increasing the amount of available returns on savings for overseas investors, thereby increasing the demand for the AUD. However, this didn’t happen immediately. Instead, the RBA’s decision led the exchange rate (AUD/USD) to fall from 0.71 to 0.69 in the days following the decision. This may be a result of Australia’s poor interest rate differential relative to the rest of the world, where interest rates are being hiked by central banks at record speeds.
However, uncertainty in the US amidst Nancy Pelosi’s visit to Taiwan and the impending economic recession has diminished demand for the USD, leading investors to redirect demand towards Australia and the AUD. Furthermore, the Chinese consumer price index hit 2.7% in July, below the expected 2.9% and the PBoC’s target of 3%. To overseas investors, this signals poor domestic demand and slowing growth, despite the export data presented earlier, leading to higher RMB supply and greater AUD demand. As a result, the exchange rate has since risen to 0.71 and appears to be on an upward trajectory.
Whilst it is hard to predict how Australia’s exchange rate will perform in the next few months, the Pound appears to be outperforming its peers. Many UK politicians and campaigners have argued that UK cost pressures are going to worsen in the next few months, but this hasn’t stopped the Pound from increasing against the USD. Notably, the Pound has appreciated from 1.19 in mid-July to 1.22 in mid-August, showcasing its resilience in the face of domestic cost pressures and overseas tensions.