Quarterly Outlook post By Michael McCarthy. Engagement with China’s higher growth saved the Australian and New Zealand economies from the worst ravages of the global financial crisis. As the world begins to journey towards a post QE-environment, this former tailwind may become an anchor unless the Tasman nations can successfully transform into less commodity dependent economies.
Commodity exports are important economic drivers in both Australia and New Zealand. Once a source of currency strength, much reduced agricultural and industrial commodity prices are helping push the Australian (AUD) and New Zealand (NZD) dollar lower.
In Australia, this is seen as unambiguously positive. As the RBA stated in April “a lower exchange rate is likely to be needed to achieve balanced growth in the economy.” Engagement with China remains important, but the emphasis is now on services and goods rather than iron ore and coal that has dominated trade in the past. However, this economic transition is occurring at a slower rate than hoped, and declining GDP growth rates and sluggish employment data have prompted the RBA to cut rates twice so far in 2015.
A lower NZD is regarded more cautiously in Auckland, NZ’s largest city and home to around a third of the population. House prices are galloping higher and international investors are at least part of the issue. Recently introduced property lending restrictions are unlikely to slow cashed up buyers from overseas. However, the offset to lower commodity prices and overall lift to the economy from a lower Kiwi dollar mean the RBNZ favour the downside and have reversed their stance to easing , at least in part to encourage further falls.
The central bankers want a lower AUD and NZD.
The question is: which will fall further? In April this year, the AUD/NZD pair hit historic lows and came within 20 pips of parity. Since then, AUD has appreciated by more than 10%. While the picture remains cloudy, once again engagement with China may be the determinant.
The “long wave” in China is a transition from an economy driven by an unprecedented national industrialisation to one led by consumer demand. A rising middle class in China will likely demand more and higher quality food. Lower demand for factories, housing and infrastructure may mean less interest in iron ore, coal and copper. In this scenario, New Zealand’s agricultural bias may see it outperform Australia’s mining dependence, leading to a stronger economy, higher interest rates and more support for NZD.
In other words, the “parity party” is still potentially on the agenda.
After a period of outperformance, largely fed by Chinese demand, the two Tasman economies may be coming back to the pack. While the two economies have many similarities, the differing commodity mix and consequent exposure to economic evolution in China could see investors and traders favouring the NZD.