The AUD is key

I painted a picture of the latest domestic surveys and stats last week arguing that the RBA would need to cut interest rates some more to try and reverse the trend deterioration in the domestic economy.

In it I briefly touched on the Australian dollar exchange rate inferring that it has not fallen enough this time.

"The A$/US$ sank from US$0.80 to below US$60 during the Asian financial crisis; it fell from around US$0.65 to US$0.49 during the US recession in 2001 and following the September 11 attacks of the same year; and, it dropped from US$0.91 to US$0.62 at the onset of the GFC," I wrote.

"The A$/US$ exchange rate has currently fallen to US$0.6786 (following the jobs report) but it has risen and remains above the US$0.6704 low plumbed after the RBA's third interest rate cut on October 1."

The A$/US$ is now back up to US$68.15.

I've long been singing praises for a cheaper currency (except for when I'm planning an overseas trip). It's good in terms of underpinning growth in the domestic economy.

Australian exporters would find their wares more competitive in the world market (even with higher tariffs). Not only that, exporters would receive an extra boost from their US dollar - or euro or yen or pound or yuan) earnings when they're translated back into Australian dollars.

Wait, there's more! Australian import-competing industries would also get a bump up as products sourced overseas become more expensive in AUD-terms, encouraging consumers to buy local produce.

Wait some more, there's one more. The cheap Australian dollar also makes Australian assets more attractive to foreign eyes.

As for inflation, a cheaper Australian dollar means more expensive imports. Of course, this will depend on whether or not domestic companies are able to pass on higher input prices to local consumers ... but the growth the cheaper A$ engenders suggests easier pass through of higher prices.

Don't take my word for it, take MARTIN's ... it's already crunched the numbers.

MARTIN - MAcroeconomic Relationships for Targeting InflatioN - is the RBA's "new full-system macroeconomic model designed to be used as part of the Bank's existing processes for forecasting and analysis ... to help understand economic developments and quantify risks."

According to MARTIN's scenario analysis: "A sustained 5% depreciation of the exchange rate is expansionary for the economy. GDP growth is roughly half a percentage point higher than in the central forecasts over the forecast period."

" The increase in GDP growth largely reflects a substitution towards Australian goods and services following the exchange rate depreciation, which leads to a reduction in imports and an increase in export volumes. This is consistent with relative price changes: the depreciation lowers the price of domestically produced goods and services relative to goods and services produced overseas.

"The pick-up in economic activity lowers the unemployment rate by around 0.4 percentage points to 41/2 per cent and raises year-ended trimmed mean inflation by around 0.3 percentage points to 21/4 per cent by the end of 2021. Around half of the increase in inflation reflects the direct effect of higher import prices and the rest comes from the indirect effects of a tighter labour market and stronger economic conditions."

The AUD is key to how low Lowe goes.

Link to something 7OpFpvHX