Lower dollar set to help strengthen Australian economy

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The Australian economy could strengthen in the new year helped by a weaker currency and the policies of central bankers in Washington.

One of the reasons the Australian dollar was above parity with the United States dollar for most of the past three years was the US Federal Reserve's economic stimulus programme.

But the Fed has announced it will reduce bond purchases by US$10 billion ($12.1 billion) this month, to US$75 billion, and more tapering is likely throughout 2014 if the US economy continues to improve.

Speculation about the timing of the Fed's tapering had already caused the Australian dollar to fall against a strengthening greenback, to its current level of about US89c.

The fall would please Reserve Bank of Australia governor Glenn Stevens, who has said the currency should not be over US90c and needs to be closer to US85c.

This would help boost the non-mining sectors of the Australian economy at a time when an important driver, mining investment, is expected to tail off.

HSBC chief economist Paul Bloxham said there were already signs the economy was rebalancing, and the tapering announcement from the Fed would definitely give it a boost by lowering the value of the Australian dollar.

"It would support the tourism industry, help to make manufacturers more competitive and encourage more local spending, rather than internet purchases from foreign lands," he said.

"Broad-based business confidence was at its highest level since 2010 in September, and consumer confidence has also bounced in recent months."

LTG GoldRock director Andrew Barnett does not expect the Australian dollar to fall too far because of the interest rate difference between the US and Australia.

"With zero per cent interest rates in the US and 2.5 per cent in Australia, in my view we're looking at the Australian dollar trading at US85c," he said.

"The fact is the Reserve Bank wants to see the Aussie down at US85c and they're going to get their way."

JP Morgan Australia chief economist Stephen Walters warns the worst hangovers often follow the wildest parties, and Australia's last five commodity booms have ended with a recession.

But he is confident it will be different this time.

"Unlike during previous such episodes, Australia now boasts an independent, nimble central bank which, crucially, has prevented an inflation break-out, and a flexible exchange rate that acts as a pressure valve for domestic excesses," Mr Walters said.

"Although the Australian dollar has not fallen as much as RBA officials hoped, it has dropped materially since the terms of trade peaked, cushioning the adjustment for the economy."

Both the RBA and the Treasury expect the economy to grow by 2.5 per cent in the 2013-14 financial year, which the RBA governor describes as below trend.

Treasury forecasts unemployment will rise to 6 per cent, from 5.8 per cent.

- AAP