Don’t Cancel That Overseas Holiday Just Yet

You can blame me. I’m the reason your overseas holiday just got more expensive.

I can pin point the precise moment the Australian dollar began its recent tumble. It was May 9. I booked a holiday to New York. It’s sods law, pure and simple. Since then, the Aussie has dropped about US5 cents against the greenback to end last week around US96 cents.

Of course, a lower dollar is a wonderful thing for our struggling manufacturers, tourism operators and universities trying to attract foreign students.

It would be churlish, surely, to complain about more expensive holidays when a lower currency means manufacturers have a better shot at staying in business and employing people.

A falling dollar is good in other ways too.

By relieving pressure on the profits of some companies, a falling dollar helps boost the federal budget. Every 1 cent fall in the dollar adds about $400 million to the budget bottom line.

And if you really want to get all Pollyanna about it, Aussie shoppers should feel grateful for the good times we have enjoyed. A higher Australian dollar was one of the main ways we all shared in the benefits of the mining boom. Aussies took a record 7.8 million trips abroad last year as we snapped up cheap airfares and set sail with empty suitcases for shopping bonanzas.

And it could still be worse. A decade ago our dollar was derided as the “pacific peso”, buying less than US50 cents. During the GFC we tumbled to US62 cents. At US96 cents, we’re still getting a pretty good deal.

But where to next? Should those of us planning US holidays start queuing outside bank branches and foreign exchange bureaus to stock up on greenbacks? Is it time to cancel that overseas holiday altogether?

Relax.

I’m not rushing to the bank and you needn’t either.

Why?

Because I’ve seen Australian dollar forecasts produced by 50 of the world’s top economic forecasting group and I’m going to share them with you. You’re welcome.

Before I tell you though, it helps to understand why the dollar has fallen over the last month, aside from my impending holiday plans.

Basically, there has been a long overdue correction in the Aussie dollar to bring it into line with recent commodity price falls. Normally when commodity prices fall, you would expect the Australian dollar to react by falling too.

But the dollar took longer to fall this time thanks to some peculiarities in global interest rates.

In a technical sense, our dollar moves up and down depending on the relative strength of demand for it among investors. Investors buy our currency both to speculate on future changes in its value and also because they need it buy Australian dollar-denominated assets like government and corporate bonds. Bonds are what governments or companies issue when they want to borrow money. Investors hand over their cash and the government promises to pay an interest rate for a fixed term.

And that’s why interest rates matter.

At 2.75 per cent, Australia’s cash rate sticks out like a sore thumb as a pretty good return in a world where interest rates are being kept close to zero in America, Japan and Europe.

Demand for our dollar has been strong, as a result, pushing up its value despite falling commodity prices.

But the dollar has finally been knocked off its perch recently by fears that our economy is not as strong as we thought – due in part to a slowing in Chinese growth – and that our interest rates may have to fall further.

At the same time, economic recovery in America has led to speculation that its central bank may soon start lifting interest rates, making rates there more attractive for investors.

It is true that the Aussie dollar could still fall further from here. That would happen if it became clear lower interest rates were needed to boost the economy now the mining boom is winding down. Slower growth in China or faster growth in America could also tip the balance against the Aussie.

But most analysts are not expecting the dollar to fall much further.

According to a Bloomberg survey of 50 forecasting groups, the median forecast for the Aussie dollar at the end of the year is parity with the US, at $US1.00.

The most optimistic forecast is at $US1.12 from RBC Capital Markets (although their senior currency strategist tells me that is under review next week).

The lowest forecast is that of Credit Suisse investment bank, which expects the dollar to end the year at US89 cents.

That would still be pretty high historically.

Why? In a word: China.

Chinese growth may be slowing, but it is still expanding at a rapid clip just under 8 per cent. Australia remains perfectly positioned to benefit from the rapid industrialisation of China and India. Growing middle classes in these countries have caught the consumption bug. Manufacturing all the TVs, cars and new homes to satisfy these new tastes will require continued import of raw materials, like iron ore and coal, which we happen to possess in abundance.

Caught in the Asian updraft, our Aussie dollar looks set to sail high for some time to come.

US96 cents
Value of the Australian dollar this week

US1.05
Value of the Australian dollar at the start of this year.

US62 cents
Value of the Australian dollar during the GFC when commodity prices tanked.

US49 cents
Value of the Aussie dollar back in 2001 after the Asian Financial Crisis.

US1.00
Median forecast for the Aussie dollar by the end of the year.

US1.12
Highest forecast among 50 economists for the Aussie dollar by year end.

US89 cents
Lowest forecast among 50 economists for the Aussie dollar by year end.

US1.11
The highest the Australian dollar has ever traded since it was floated in 1983 (in July 2011).

US1.49
The highest the Australian dollar ever traded while it was pegged against the US dollar (in 1973).

By Jessica Irvine, National Economics Editor news.com.au