The Australian Dollar’s value hinges significantly on the economic landscape of China, the nation’s largest trading partner. Australia has long been known as the lucky country, primarily exporting its abundant natural resources, with iron ore as the nation’s top export. Recent economic data from China, including the Manufacturing Purchasing Managers’ Index (PMI), suggest a contraction. This has led to fears over the longer term effects this could have on the Australian economy and the strength of its currency.
In April, China’s official PMI dropped to 49, under the market consensus of 49.9. This recent downturn represents a deep contraction in manufacturing activity. This important sector has a huge effect on Australia’s export demand and national economic performance. China’s economic woes are sending shockwaves through Australia’s financial landscape. One sector feeling the pressure more than others due to this uncertainty is the Australian Dollar.
The Resource-Rich Backbone of Australia
Australia has an about as good a wealth of natural resources go. These assets help power the country’s economy engine. Iron ore especially has become the lynchpin of Australia’s export economy. Today, the country is one of the largest producers and exporters of iron ore in the world. China is more than happy to gobble up most of this supply.
The dynamic between Australia’s exports and China’s demand is key. When China’s economy is robust, it tends to increase its purchases of raw materials, including iron ore, which in turn boosts Australia’s economic growth. Therefore, a high demand for Australian exports often results in an appreciation of the Australian Dollar.
Changes in China’s economic status may make this connection unpredictable at times. Clearly, the recent step back in China’s manufacturing sector increases concerns over future Chinese demand for Australian resources. A significant slowdown in demand for iron ore would likely put downward pressure on the Australian Dollar as foreign buyers reconsider how much iron ore they want to buy.
Economic Indicators Impacting the Australian Dollar
Many other important factors drive Australian Dollar value, not just trade picture with China alone. Australia is notable in that inflation rates have a strong effect. When inflation increases, it oftentimes causes shifts in monetary policy that directly affect the value of the currency. Finally, Australia’s growth rate is an important signal to investors looking at the long-term economic picture.
Additionally, Australia’s trade balance—indicating the value of exports minus the value of imports—is eternally important. A trade surplus, driven by high demand for exports like iron ore, can bolster the Australian Dollar’s strength against other currencies. If the opposite is true and imports are greater than exports, the currency will likely depreciate. Either through weak global demand or through unfortunate increasing reliance on foreign produced goods.
The recent PMI data out of China serves as an important reminder on just how connected Australia’s economic fortunes are to its biggest trading partner. A positive surprise in China’s growth data can lead to increased demand for Australian exports, thereby propelling the Australian Dollar’s value higher. In contrast, there is a harmful impact from the negative surprise.
The Ripple Effect of China’s Economic Performance
The performance of China’s economy sends ripples through global markets, notably impacting Australia’s currency. So when China’s economy is booming, that’s a sign that there’s strong demand for all of the raw materials and goods that Australia supplies. This situation increases foreign investment into Australia and foreign demand for the Australian Dollar.
Just as with a successful currency, as demand rises, so does the value of the currency. The excess demand this generates from foreign buyers wanting to buy Australia’s exports puts upward pressure on the value of the Australian Dollar. Even the slightest hint of a slowdown or large economic contraction in China would lead to a swift depreciation of the currency. In that situation, traders would rapidly revise their expectations to account for those new demand projections.
Recent headlines that focus on China’s Manufacturing PMI falling into contraction at 49 should remind all of just how pronounced and dynamic these themes can be. Analysts were looking for even more, making the reading a big disappointment. They are already speculating about how this will affect Australia’s trading partnerships, and the effect on the Australian dollar’s value.