Australia Cuts Interest Rates on Currency Slide

After the worst month on record for the Australian dollar, the nation’s central bank cut its key rate to 2%.

That represents a 25 basis point cut which many analysts had expected. The decision was made as Australia fights falling inflation and weakening exports, as a fall in commodity prices—Australia is a net energy exporter—combined with lower demand in China—the country’s largest trading partner—contributed to economic weakness and a fall in the currency’s value.

After the worst month on record for the Australian dollar, the nation’s central bank cut its key rate to 2%.

That represents a 25 basis point cut which many analysts had expected. The decision was made as Australia fights falling inflation and weakening exports, as a fall in commodity prices—Australia is a net energy exporter—combined with lower demand in China—the country’s largest trading partner—contributed to economic weakness and a fall in the currency’s value.

Reserve Bank of Australia Governor Glenn Stevens focused on inflation in announcing the change, saying that low interest rates will stimulate domestic activity. “The inflation outlook provided the opportunity for monetary policy to be eased further, so as to reinforce recent encouraging trends in household demand,” he said, adding that “low interest rates are acting to support borrowing and spending, and credit is recording moderate growth overall, with stronger lending to businesses of late.”

Stevens also said the Australian dollar is likely to fall further, particularly against the robust U.S. dollar. “The Australian dollar has declined noticeably against a rising US dollar over the past year, though less so against a basket of currencies. Further depreciation seems both likely and necessary, particularly given the significant declines in key commodity prices,” he said in a statement.

The Australian dollar trades for less than 79 U.S. cents. In late 2013, the Australian dollar traded over parity, but the currency has lost a quarter of its value since then.

Falling Exports

Australian exports have seen steep declines, as the country is dependent on mining and raw materials exports, particularly metals and coal, which has fueled China’s surging growth. However, a deceleration in Chinese growth, which some economists believe is likely to fall below its 7% GDP growth target for 2015, has pressured Australian exporters, and put high salaries and low unemployment in Australian mining at risk.

Labor Participation Concerns

Already, Australia saw a rise in unemployment throughout 2013 and 2014, with the unemployment rate growth accelerating in late 2014 as commodity prices slid. In 2015, the rate has normalized slightly, falling to 6.1% from a high of 6.4% in January 2015. In March, Australia added 37,700 jobs, helping its labor participation rate rise to 64.8% in March.

However, Australia is also seeing a sharp rise of people going from full employment to leaving the labor force, with 240,300 people making this transition from February to March 2015. At the same time, 166,300 people went from out of the labor force to employed, and 80,300 went from employed to unemployed. Although 131,100 people moved from unemployed to employed, mostly offset that, the demographic headwind of a larger number of people leaving the labor force could threaten Australian growth in the future.

Economists are especially concerned about the nation’s large dependence on growth in housing prices and its reliance on commodity demand in China.