Low commodity prices reflected in Australia’s economic performance and currency

Australia's economic performance remains relatively soft, partially reflecting low iron ore prices and weaker import demand from China. Real GDP grew by 0.2% q/q (2.0% y/y) in the second quarter of 2015 following a solid 0.9% q/q (2.5% y/y) advance in the first three months of the year. 

Despite registering below-trend output growth, activity will be underpinned by a higher volume of resource exports - offsetting material price declines - on the back of increased mining capacity following several project completions. Private investment will remain a drag on economic momentum on the back of declining mining sector outlays.

ousehold spending will be supported by accommodative monetary conditions and strong house price gains, yet consumer sentiment remains muted due to a relatively weak, though improving, labor market and ongoing global uncertainty. The government has eased its position on fiscal consolidation, yet public expenditure will not be a significant source of economic growth. 

Monetary conditions in Australia are set to remain accommodative over the coming quarters. The Reserve Bank of Australia (RBA) lowered the benchmark interest rate by 25 basis points to the current record low level of 2.00% in May and has kept the key rate stable following subsequent monetary policy meetings, most recently on September 1st. The RBA is constrained from lowering interest rates further given risks stemming from relatively high household debt. Inflation rose slightly in the second quarter of 2015 to 1.5% y/y, yet it still remains below the RBA's 2-3% target. 

The AUD is weak and likely to remain so over the near-to-medium term, pressured by a combination of weak drivers relating to central bank policy, commodity prices, financial market volatility, and sentiment. The AUD's steady decline has provided for fresh lows below 0.7000, to levels last seen in early 2009. AUD risk is biased to further downside, as we consider the relative outlook between the US Fed and RBA, with the added risk of continued weakness in commodity prices given concerns surrounding the path of growth for China. 

Recent financial market turmoil has sparked a flight toward safe-havens and away from growth-sensitive risk currencies such as the AUD, weighing on investor sentiment and pushing AUD bears to hold a near-record gross short CFTC position. The $3.9bn net short position is wide, though still shy of the $5.9bn position from March 2015 and the record August 2013 short near $7.1bn, leaving some room for a further build.