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Why does depreciation help no more in raising the Australian CPI?

Discussion in 'Fundamental Analysis' started by FXStreet_Team, Nov 27, 2015.

  1. FXStreet_Team

    FXStreet_Team Well-Known Member Trader

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    FXStreet (Mumbai) - Data compiled by Bloomberg noted that the Aussie dollar has slumped 38 per cent since July 2011 and yet the cost of living has risen only 8 per cent. This data from the post-global financial crisis era marks a shift in trend noticed earlier. Earlier, a fall in a country’s currency would lead to a rise in consumer prices as the cost of imported goods would increase. This is exactly what had happened when Australia first adopted a flexible exchange rate back in 1983.

    Is depreciation a redundant tool today?

    Since 1983 there were four long term periods of depreciation. CPI increased 16 per cent as the local dollar depreciated 38 per cent from March 1984 to July 1986 while between February 1989 and September 1993 the local dollar fell 28 per cent and the CPI increased 18 per cent. The December 1996 to April 2001 period saw 42 per cent drop in the Aussie dollar and a 11 per cent rise in CPI.

    In the current period (July 2011 to September 2015), the CPI rose only 8 per cent currency though the currency has 38 per cent. This year alone the currency has fallen 12 per cent.

    Today, cheaper currency no longer raises exports or boosts wages. Exchange rate thus no more remains a powerful toll in the hands of central banks to control adverse consequences resulting from a slide in an economic indicator. This leaves policy makers a little worried.

    The struggle today is to create inflation and not fight it

    One factor that probably responsible for keeping prices depressed is that with the exception of few emerging economies in Latin America there is little or almost no inflation anywhere else in the world. Which means even if central banks allow currencies to fall they cannot import much inflationary pressure from outside as well.

    Reserve Bank of Australia Governor Glenn Stevens is surprised at the current lack of price pressure in the economy given that that the country have always had inflation higher than in major developed economies. The central bank decided to keep rates steady at 2 per cent despite the unflattering inflation figures. In his speech this Tuesday he noted that despite zero interest rates and quantitative easing in the U.S., U.K. and Europe inflation hovered around zero. He said he had no problem in cutting rates further only if he was convinced that it would help. He has warned that cutting rates now would not lead to the kind of benefits that it used to provide to stimulate the economy when rates were cut from very high levels in the 1990s.

    May be the history of Australia’s economy is prompting him to be a little too hawkish. However James McIntyre, head of economic research at Macquarie Group Ltd. in Sydney feels that the past has often been an “unpredictable guide for the future” McIntyre believes that today “Generating inflation rather than fighting it is the global challenge.” Based on the assumption that slashing interest rates can raises prices by stimulating demand, McIntyre predicts Australia’s central bank will further cut its already record-low benchmark interest rate of 2 per cent early next year.

    Wages, prices not helped by depreciation any more

    Prices:

    The governor admitted that the impact of the decline in exchange rate is taking time to yield results and that low inflation in Australia in the three months through September “contained some signal, not just noise”. Australia’s inflation rate came in at 1.5 per cent in the third quarter, below the central bank’s 2 per cent to 3 per cent target.

    Jo Masters, a senior economist at Australia & New Zealand Banking Group Ltd observed “Prices are consistently falling for both clothing and audio visual and computing equipment despite a sharply weaker currency.”

    Craig James, a senior economist at the securities unit of Commonwealth Bank of Australia feels “Every business around the world is under a new imperative in terms of keeping prices low.” Prices in Australia have been further hurt by low-price foreign entrants into Australia. In the struggle to retain business the supermarket chains like Aldi and clothing outlets like H&M and Uniqlo Co have entered into a price war.
    The situation could worsen in the coming days as more brands look poised to enter the Australian market. Deloitte estimated 85 per cent of the world’s top 250 retailers are not yet in Australia.

    Wages:

    Wages have moved at the weakest pace since the last recession, a quarter century back. Real wage growth in Australia stagnated as high-paying mine jobs made way to an increase in number of people joining the service industries. What is worrying is that workers’ pay rates have not been rising even though the labor market has shown steady improvement.

    It has been observed in Australia as also in other similar the U.S., U.K. and Germany, there is a strong jobs growth; however pay demands that would drive consumer prices higher are almost absent.
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