• Australian dollar hits parity with US dollar, could hit 1.05 USD in coming months
• Cotton hits record price on strong Chinese mill demand and downgrades to global production
• Sugar prices could hit 30 USc/lb on near term supply concerns

NAB’s outlook for the Australian economy remains unchanged since last month, with Australian economic growth of 3.25 per cent expected in 2010 and 3.75 per cent expected in 2011.

Consistent with a multi-speed economy, forward indicators are generally mixed. Retail continues to struggle as do the tradeexposed sectors outside the mining sector, while signs are emerging that construction is improving. Looking ahead,
national income is likely to be bolstered by minerals exports given the strong and improving outlook for Australia’s trading
partners.

The Australian labour market continues to show strength, with signs of a pick-up in labour force participation in recent months and improvements in both employment numbers and hours worked. Low unemployment is expected to support
consumption in the coming quarters although retailers are currently finding trading conditions difficult.

A key question going forward is whether private sector investment will fill in the gap left by the withdrawal of the fiscal
stimulus. The mining boom will be a critical driver of economic growth going forward, and while we are seeing signs of the
current boom, we are yet to see the full impacts.

On the international front, NAB forecasts the global economy to expand by 4.6 per cent this year, slowing to around 4.4 per cent in 2011. While momentum of growth is slowing in some of the big developed economies, the flow of partial economic indicators and business survey readings does not point to a double dip recession. The emerging market economies are playing a much more prominent role in driving growth with rapid rates of economic expansion in China, India and Brazil expected to continue into 2011.

AUD hits parity with USD
The AUD hit parity with the USD in mid October. But it wasn’t just the USD with which the AUD has shown strength. The AUD ended September higher against all major agricultural trading partners. When weighted against a basket of major trading currencies, our dollar ended the month 5.9 per cent higher in September.

The recent rally in the AUD/USD is largely due to the divergence in the underlying fundamentals driving the two currencies. Chinese demand for raw materials has seen the Australian economy enter its biggest terms of trade boom since the nineteenth century. Given the income boost generated by this and the flow on effects through the economy,
market expectations of further rises in the cash rate have firmed, with NAB expecting interest rates to be 100 basis points higher by next August.

In the US, however, interest rates are near zero and the Federal Reserve is gearing up for a second round of quantitative easing which could boost the money supply by up to US$1 trillion. This is likely to be a drag on the USD and given expectations of interest rates remaining low, the AUD is likely to hit 1.05 USD over the near term, and could trade as high as 1.10 USD over the next six months.

Tight supplies buffer agricultural exports, for now
Fortunately for the Australian agricultural sector, we have not seen the full impacts of the high AUD yet. Export data confirm this, with exports in value terms continuing to rise and indications that Australian producers have been receiving good export prices for commodities. The current tightness in global soft commodity markets has provided a temporary buffer against the high AUD and many producers have managed to lock-in high prices for much of their production.

However, this buffer will not last long. We know that globally producers are trying to capitalise on the high prices on offer by ramping up production and we are already seeing planting intentions for next season picking up. This will begin to exert significant pressure of Australian producers as more supply becomes available. Barring any significant global production shocks, the high AUD should start putting considerable pressure on agricultural exports by early 2011.

Net Value of Farm Production
Overall production volumes are relatively unchanged from last month while rising global prices are largely offset by a rising Australian dollar and with livestock exports being revised down slightly. Given this, NAB expects the net value of agricultural production to increase 57 per cent in 2010-11 to $9.7 billion. The gross value of farm production is likely to increase by 12.8 per cent to $46.6 billion in 2010-11.

Source: NAB Economics

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