The Australian economy: Adjusting to the euro crisis and weaker growth in China

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Australia has macroeconomic problems that the US and much of Europe can only dream of. Investor confidence in the country is indicated by the strength of the Australian dollar (AUD) trade weighted index, which is at 1.5x standard deviations above the ten-year average.

Relatively strong and stable growth, strong demand for commodity exports, high interest rates and sound government finances have all contributed to the strength of the Australian dollar over the last decade.

But more recently, worries of a Greek exit from the euro and contagion across the eurozone have strengthened the US dollar (USD) against emerging currencies and more cyclical developed world currencies, such as the AUD.

There is concern that slower global growth, resulting from contagion in the eurozone coupled to slower than expected Chinese growth, may lead to reduced demand growth for industrial metals and to slower growth in Australia.

The result is a careful balance of monetary and fiscal policy. The Reserve Bank of Australia surprised the financial markets in early-May with a 50bp interest rate cut, taking policy rates down to 3.75%, while the government maintains a tight fiscal policy with a declared intention to running a budget surplus this year.

The aim is to preserve growth while keeping the lid on inflation as monetary policy easies and the AUD weakens. With J.P. Morgan Asset Management estimating 2012 GDP growth at 3% and CPI inflation currently at 1.6%, other countries must be envious of the dilemmas facing Australian policymakers.

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