Australia’s reversal of fortune

The Australian dollar is flying high. It has gained more than 10% since last autumn and now buys 1.05 American dollars. But the signs of a reversal are mounting.

One key influence on sentiment towards the Australian dollar is China, which now takes almost 40% of Australia's mineral exports and 23% of Australia's overall exports. Investors "have every justification to be concerned about the decided downshift in China's growth performance", says Fxpro.com.

Signs of a hard landing are mounting. Among the most eye-catching statistics is that crude steel production is now barely positive, down from a growth rate of 40% in late 2009. It's not just China; global trade has slowed too, says Morgan Stanley. Australia recorded its first trade deficit in 11 months in January.

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Furthermore, the risk of recession in the non-mining economy "is now real", says Tim Colebatch in The Sydney Morning Herald. The strong Australian dollar has encouraged some firms to move production overseas, while household debt worth 150% of disposable income has hampered consumption, which in the fourth quarter of last year advanced at the slowest pace in almost two years. Unemployment has crept back over 5%.

To make matters worse, Australia's housing bubble, which saw prices rise six-fold in 25 years, now finally appears to be bursting. Prices in Brisbane and Perth have slid sharply and in Sydney and Melbourne second homes and holiday flats are being sold off rapidly, says Fxpro.com. With the overall economic outlook darkening, many indebted households could become forced sellers and demand will slow further.

Australia may merely have postponed, rather than avoided, the property and credit collapse seen in the rest of the developed world in 2008-2009. Back then, after growing continuously since the early 1990s, it was boosted by China's stimulus package. Interest rates now look set to fall, which will reduce the appeal of its dollar for international investors.

Australia's dollar is also a key barometer of global risk appetite, adds Morgan Stanley. This may ebb now central banks seem less inclined to keep adding liquidity to markets. The Australian dollar looks "increasingly vulnerable" and could be back just below parity with the US dollar by the end of the year.

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