The Terms of Trade Tumble – Interest Rates Need to Follow

The export and import price data for the March quarter confirm what the RBA has been saying for some time – the terms of trade are falling.

From what is now clearly a peak in the September quarter 2011, the terms of trade have dropped by 9.5% in the two quarters since.  To be sure, the terms of trade are still historically high, but a 10% downturn in a soft global environment is nothing to be sneezed at.

One of the more interesting parts of the recent market trends in that the Australian dollar has actually risen by around 1% while the terms of trade have fallen 10%. 

And before the cherry pickers query this fact, and probably cite the fall of the AUD from 1.10 to 1.03, please note that the average level for the trade weighted index of the Australian dollar was 75.8 points in the September quarter and yesterday, it was 76.7 points.  Some of the AUD fall in recent weeks have been against a stronger USD meaning the AUD is still buoyant on the cross rates.  And that’s what counts when it comes to export competitiveness or the lack thereof.

The RBA has, in recent months, noted the gap emerging between the terms of trade and the AUD.  Today’s  confirmation of that with the terms of trade data will only reinforce that view.

One reason why the gap has opened is unambiguously the interest rate structure that has prevailed for the last four months as the RBA has refused to lower official interest rates.  The AUD looks like a bubble that is getting a little bit of extra inflation from the RBA policy stance, but that can and will change in the months ahead.

The terms of trade data today will add a little more spice to the RBA Board discussion on 1 May on whether the cut should be 25 or 50 basis points.