Aussie dollar turns villain for RBA as transition under threat

Marcus Newton
August 3, 2017

"The Australian dollar has appreciated recently, partly reflecting a lower USA dollar".

'The higher exchange rate is expected to contribute to subdued price pressures in the economy.

While this had been largely priced in by investors, the RBA's warning that the 'Aussie's recent strength has been placing pressure on the Australian economy caused the antipodean currency to relinquish almost all of its overnight gains.

For investors the question is whether the Australian dollar will revert lower most likely as the U.S. Federal Reserve lets on that investors are underestimating the proximity of further cash rate hikes.

Central bankers all around the world are in a Machiavellian-style battle to keep their own currencies lower in order to boost competitiveness and inflation, while avoiding a Keynesian liquidity trap where monetary policy via lower rates fails to stimulate demand as intended.

At its meeting today, the Board made a decision to leave the cash rate unchanged at 1.50 per cent.

The economy is forecast to grow at an annual pace of around 3 percent over the next couple of years.

One way to alleviate the upward pressure on the Aussie dollar, would be to cut interest rates even further.

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The Reserve Bank remains hopeful that tighter prudential rules are beginning to bite.

Conditions in the global economy are continuing to improve.

Indeed, at a recent speech at the Anika Foundation Luncheon in Sydney, RBA Governor Philip Lowe said that "the persistent slow growth in wages is creating a challenge for central banks". The economy is nearly out of the reversal of mining investment that had been weakening growth of late - another bonus.

There is also likely to be a short-term pick up in inflation, as measured by the consumer price index, as higher electricity and tobacco prices flow through.

He adds that there are two schools of thought about this, with the first composed of optimists, for whom, "the strength of the service sector, representing 80% of the economy, shows the underlying resilience of growth with services now 2.3% bigger than a year ago", whilst pessimists argue that the, "falls in production output are being masked by a short-lived expansion of services that's doomed to fall victim to the real income squeeze". In other words, the RBA's fortunes are hitched to those of the White House. But Dr Lowe noted that "a factor working in the other direction is increased competition from new entrants in the retail industry".

He said Dr Lowe's reference to higher commodity prices against the backdrop of expected weaker terms of trade also indicated the RBA was unconvinced a recent bounce in commodity prices was sustainable. The various forward-looking indicators point to continued growth in employment over the period ahead.

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