The Australian economy

  • Oct 17 2022
  • by
  • Analyst AZA
The Australian economy

The Australian economy

Australia is the 12th largest economy in the world and the 3rd largest economy in Asian territory. It is on the same level as the industrialized countries of the west in terms of a per-capita basis. Australia is a service-orientated economy, with over 70% of its GDP coming from industries such as business services, property, and finance. However, the country has been running a trade deficit, with manufacturing accounting for the majority of the exporting activities. Minerals and rural exports account for more than 12% of GDP and 60% of manufacturing exports. This makes the Australian economy highly sensitive to the movements in the commodity markets. Due to its dependence on exports, the growth rate of Australia's major trading partners requires close monitoring.

Australia's most important trading partners are Japan, South Korea, the United States, New Zealand, and China. The major exporting countries are Germany, Japan, Singapore, the United States, and China. China is its number one trading partner of Australia. China mainly imports gold, natural gas, iron ore, and coal from Australia. 70% of Australia's exports are to countries that are part of the Asian Pac. This makes it very important to Australia. Negative economic shocks from China have severe impacts on Australia, not only in terms of trade activities but also on the housing market activity. The relationship between Australia and China is referred to as Sino-Australia relations. China has been producing its resources, which should have big ramifications for the Australian economy. The Central Bank of Australia is known as the RBA.

The RBA is responsible for ensuring that the economy of Australia prospers, full employment is maintained, the stability of the Australian dollar, and the welfare of the Australian people. The Central Bank has the responsibility of ensuring the inflation target is between 2% and 3% per year. The RBA has a core belief that for the economy to have sustainable growth, there is a need to control inflation, which would ensure the currency's value is preserved. Inflation targeting provides guidelines for private sector expectations of inflation, and discipline for conducting monetary policy. This also improves the transparency of the central banks' activities. If the inflation expectations or inflation goes above the target, it would raise red flags at the Central Bank and will result in the RBA adopting a tighter monetary policy. Monetary policy actions include setting rates on overnight loans.

Most interest rates will be directly or indirectly impacted by this rate to varying degrees so that the activities of lenders and borrowers in the financial markets are affected by the monetary policy. Through these actions, the central bank can reach its monetary policy objectives. The provision of liquidity to commercial banks allows open market operations to keep the cash rate close to their target. When the central bank decides to reduce the cash rate, it will have to increase the supply of repurchase agreements that are short-dated at a lower rate than the cash rate. As a result, the cash rate will decrease. A repurchase agreement takes place when a commercial bank sells securities to the RBA, with an agreement to buy back securities of the same quantity and type at a later date. This agreement tends to have short-dated maturities, ranging from a day to two weeks.

Australia has been maintaining a floating exchange rate since 1983, and the RBA won't hesitate to intervene in the currency market when the market is becoming extremely volatile or when the underlying fundamentals are not consistent with the exchange rate. The RBA monitors the AUD / USD pair and the trade-weighted index. The central bank's intervention goal is for market stability rather than targeting exchange rates. The RBA's meeting is held once every month, excluding January. The meetings are held on the first week of every month to discuss potential changes in monetary policy. After the meeting, the RBA will hold a press conference, in which they will clarify their objectives to the public. If the interest rates remain the same, there won't be any statements published.

The Aussie is a commodity-linked to the currency, meaning it has a high correlation with commodity prices, especially iron ore and gold prices. This is a result of Australia being the world's largest iron ore producer and one of the largest producers of gold. Therefore, the price of gold and iron ore will have significant ramifications for the Australian dollar's performance. However, unless there is an aggressive movement in iron or gold, in most cases it will take time for the Australian dollar to adjust to the movement in commodities. If commodity prices go up, inflationary fears will start to rise, and the central bank will be forced to raise raises to fight inflation. It is worth noting that in times of geopolitical uncertainty, gold prices tend to go up and if the central bank hikes rates during these conditions, Australia could be vulnerable to spillover effects.

Australia has been known to maintain one of the highest interest rates among developed nations due to its fairly liquid currency. The Aussie has also been a currency of choice for market participants wishing to execute carry trades. The country's GDP is very sensitive to adverse weather conditions that may interfere with the performance of the agricultural sector since the majority of Australia's exports are commodities. For example, in 2002, Australia experienced a severe drought, which took a toll on the economy. Agriculture accounts for 4% of GDP.  Therefore, this was a significant event. During the time, the central bank estimated that the drought was going to reduce GDP growth by around 1%. This will spill over to economic sectors that have exposure to agriculture. For example, the wholesale and manufacturing sectors were also going to experience shocks. Nevertheless, Australia is known to bounce back strongly after the effects of the drought start to dissipate.

Thanks for reading and good luck.

Australia has been maintaining a floating exchange rate since 1983


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