Australia Economy Struggling

Australia is caught in a disconnect between the trajectory of its key commodity export and a currency that refuses to follow suit, constricting an economy that policy makers are trying to stimulate.

Iron ore has slumped 30% since Chinese Premier Li Keqiang signaled plans on March 5 to cut his nation’s steel capacity. The world’s No. 2 economy is Australia’s biggest trading partner and iron ore exports account for more than 3% of Aussie GDP. The Aussie dollar, meanwhile, has barely budged in the past month as it trades around US75 cents, AAP reported.

“Really, it should be going lower,’’ said Andrew Ticehurst, a rates strategist at Nomura Australia in Sydney, who notes a declining US dollar is helping prop up the Aussie.

“If commodities are falling appreciably and the currency’s not offsetting it, that’s a net tightening in financial conditions and becomes more of a headwind.’’

Meanwhile, interest-rate bets have moved: traders are now pricing in a one-in-five chance the Reserve Bank of Australia will end a pause in September and lower interest rates by a quarter point from the current 1.5%.

That’s a turn away from the consensus view: that policymakers can’t cut for fear of further inflating property prices and household debt; and can’t tighten to contain the housing market because weak employment, record-low wage growth and subdued inflation suggest it would hurt the economy.

Iron ore has had a volatile 18 months: it slumped to a low of just over $38 in December 2015, then steadily rebounded until it reached a peak of just under $95 in February this year; it has since slumped to a bit over $63.

The RBA’s head of economic analysis Alexandra Heath earlier this month pointed to the policy-driven nature of Chinese demand—how authorities in Beijing can ramp it up or cool it down.

Li’s announcement of a target of cutting about 50 million tons of steel capacity this year pulled the floor out from the iron-ore price in March, particularly as his goal is part of a plan to reduce steel capacity by 150 million tons through 2020.

The disconnect between the Australian dollar and iron ore is unusual for the small, commodity-based trading economy. Matthew Peter, chief economist at QIC Ltd. in Brisbane, says one of the reasons the currency may not be declining now is that it didn’t run up that much during last year’s iron ore rally.