Appreciating $A may stymie recovery

The foundation of all emerging recovery in credit markets remains uncertain to a large degree. The assumption being made is that we have entered a V-shaped recovery. This still seems like a big call to make, especially if we are relying on Australia continuing to outperform the rest of the developed world.

It's worth noting that the Bank of England and the European Central Bank saw no case to increase their cash rates on Thursday night, our time, nor did the South Korean central bank on Friday.

The other big short- to medium-term risk for Australia is the appreciation of the Australian dollar. This is not just a story of US dollar weakness either. Since the start of this year the Australian dollar has appreciated 19 per cent against the Euro, 14 per cent against the British pound and 22 per cent against the Japanese yen, while appreciating 24 per cent against the US dollar.

Rising interest rates, a booming stock market and an appreciating currency itself, will continue to attract strong international capital flows that will simply exacerbate the situation. The Australian dollar could well exceed parity this time around, and the risk is that it will ultimately take the economy to a current account crisis. (New Zealand will probably be dragged along for the ride.)

As John Hewson pointed out in the AFR on Friday, with all the other economic excitement last week, the markets ignored the trade data that showed our exports have collapsed by one third from their peak one year ago - the sharpest decline in 38 years. Of course, this is not all due to the appreciation of the Australian dollar; volumes have also fallen as demand for our products from the rest of the world has sharply declined.