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Rate rise ‘unsustainable’

ANYONE who professes to know where the Aussie dollar is headed would only be kidding themselves or their audience.

After the Prague meeting of the finance ministers of G7, it announced to the world that it intended to do something about the weakening Euro against the US dollar.

The market was initially very impressed and the Euro rallied 4¢ almost immediately to close at 90¢ against the US dollar.

Interestingly, it took the Aussie with it and our currency went to the dizzy heights of 56¢ before the market began to question whether the G7 group could sustain a reasonable level of buying of the Euro against the US dollar, sending the Euro back to close at around its previous levels.

This highlights the incredibly tangled web that determines the value of the different currencies.

In a recent article in BT Funds Management’s Investor Circle magazine, Dr Chris Caton, BT’s chief economic adviser, indicated that he had rated by The Australian Financial Review as the second best forecaster of the Australian dollar for the first half of 2000.

“Pretty pleasing, but I’d have been much happier if I’d got the direction right,” he said.

“I thought our currency would rise slightly to US67¢ by the end of June. Instead it fell to about 60¢. Obviously, if I was the second best forecaster, everyone else got the direction wrong as well!”

This highlights the incredibly difficult task for economic forecasters who attempt to predict the direction, level and value of the Aussie dollar.

For the past 15 years, there was a very tight link between the levels of commodity prices and the value of our dollar. When the world economic growth levels rose, so did commodity prices and our currency.

Why has this not happened now? Some economists have indicated that the answer lies in the “new economy-old economy” scenario.

We are an “old economy” and therefore don’t qualify for the cash flows that have been going to the US and other parts of the world.

Our technology sector is 3 per cent of the total market whereas in Asia it is as high as 29 per cent. Therefore, at a time when technology stocks are booming, we get bypassed as far as cash flows are concerned, restraining the currency to the extent that it has.

But Dr Caton said the model determining our currency also seems to be shifting.

“Generally, currency movements are driven by trade flows, interest rate differentials and investment flows,” he said.

“In recent years, interest rate differentials have apparently replaced trade flows as the primary driver of currency movements.

“Australia’s interest rates are lower than US rates. So foreign investors invest in America – pushing down the demand (and value) of our dollar”.

So there lies the answer to the currency question – the currency has struggled against the US dollar because of the higher – relative to ours – interest rates on offer there.

This was recognised by the Reserve Bank when it undertook its last tightening. The option for the Reserve is to increase the rates again. But can the economy sustain another rise?

It would seem not. The increase in fuel prices has already started to act as an effective brake for the economy.

Coupled with a slow down in housing and the imposition of the GST there are sufficient reasons to minimise the growth of the economy naturally, without the need for a “Reserve-induced hard landing”.

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