Strong growth... Weak Aussie dollar?

The Australian economy is expanding at the fastest pace in 6 years... yet the Australian dollar hit its lowest level in more than 2yrs.

Global markets have been hit by waves of contagion in emerging markets these last few weeks. The Turkish Lira has lost 30% of its value in the second half of 2018 so far; the Argentinian peso 23% and the South African rand 10%. In recent days, the Russian Ruble has also slumped and is down 10% so far this half.

So going into Australia’s Q2 GDP on Wednesday, traders could have been excused for being tilted towards the risks of a softer outcome.

However, growth came in well above expectations. Real GDP expanded by a solid 0.9% in the June quarter and annual growth printed 3.4% versus market expectations for annual growth 2.8%. Indeed the range of market forecasts was from 2% to 3.2% meaning annual growth came in 0.2ppts above even the highest forecast among 25 economists.

Now to be fair, the 0.6 percentage point difference was due to a combination of upward revisions totalling around 0.4 percentage points and stronger than expected growth for the June quarter of 0.2 percentage points.

However, this was the strongest year on year growth since the third quarter 2012 - significantly stronger than we had been led to believe and, comfortably above the generally accepted measure of potential growth for Australia of 2.75%.

Now, there are plenty of qualms about the sustainability of growth, with the drought likely to become evident in H2 data and slow wage growth squeezing the consumer. The tightening in domestic financial conditions plus increased global trade tensions may have an impact in the second half too.

However, Australian commodity export prices remain strong. The average thermal coal export price was $110 in August up 42% versus a year ago. The average spot LNG price in August was $10.6, up 80% versus a year ago. And while the average iron ore price were down 12% year on year in August, export volumes have risen solidly, emphasising that the terms of trade is providing significant support for the Australian economy.

Now in stark contrast to all the above, the A$ hit more than 2yr lows on Wednesday the same day the GDP report was released. The RBA noted this weakness on Tuesday in their Monetary Policy Decision – noting “it has depreciated against the US dollar along with most other currencies”.

So why was the AUD the second-weakest G10 currency over the week?

The ongoing stress in emerging markets including near-neighbour Indonesia and rising trade tensions between the US and China with risks of more to come in coming days have clearly been a factor. The out of cycle tightening in standard variable mortgage rates by the banks in Australia has also weighed on sentiment too.

The strength of the US economy with the Fed set to hike rates later this month, with another in December have helped strengthen the US$ too.

Now next week we have more up to date domestic data which may highlight the impact of domestic politics on confidence – the Aug NAB business confidence is out Tuesday, Westpac-MI consumer sentiment on Wed and Aug employment report Thu.

Thursday brings two important central bank meetings with the ECB and Bank of England policy updates. US CPI for August is released the same day too. These are all factors we can talk about in next week’s markets update.