Jane Foley, the senior FX strategist at Rabobank, notes that it has been 28 years since Australia last fell into recession and the recent flattening of yield curve in response to slowing growth both domestically and internationally is fuelling the debate about whether a significant downturn is now inevitable.

• “So far this year the RBA has already cut interest rates twice, bringing its policy rate down to 1%. The pre-emptive nature of the central bank’s policy may have been partly aimed at pushing down the value of the AUD, which has dropped by 3.8% vs. the USD in the year to date. The drop in the policy rate combined with market expectations that further cuts are in the pipeline has also encouraged a debate about the likelihood that the RBA could resort to quantitative easing in the foreseeable future. This would likely further depress the value of the AUD.
• There is speculation that commercial banks in Australia could be unlikely to pass on any rate cut in the RBA’s main policy rate below the 0.50% level. This is related to concerns about the impact on deposits and fears about the impact on their net interest margins.
• In terms of the outlook for the domestic economy, it is not all bad news. Aided by the drop in interest rates, evidence is growing of a stabilisation in the housing market and this can be expected to have a positive impact on consumer confidence. That said, the labour market is posting some worrying signals.
• On top of the subdued inflation outlook, the Australian economy is vulnerable to slowing growth in China.
• Not only does weakness in the Chinese economy have negative implications for Australia and the AUD through various trade channels but the associated rise in risk aversion can also pressure the exchange rate. Although Australia’s current account deficit % GDP has fallen, this can still increase the sensitivity of the AUD to bad news. We expect AUD/USD to head towards 0.65 on a 12 month view.”