The currency war will be on in earnest in 2013 as the United States, Europe, Japan and China all step up efforts to get to their exchange rates down. This will have dramatic consequences for Australia and for the Reserve Bank.
Specifically, ANZ’s chief economist Warren Hogan is right: official interest rates are heading lower, probably to 2 per cent by this time next year. The main beneficiary of this will be the housing market, which has already bottomed thanks to this year’s cuts and will continue to recover in 2013.
Will lower rates get the dollar down? Probably not, which means that either the Reserve Bank will have to take more direct action on the exchange rate or watch Australia’s non-mining industries (apart from housing construction) continue to shrink, painfully.
So next year Australian businesses and investors should see a unique combination: a persistently high exchange rate and historically low interest rates.
In simple terms, this means weak manufacturing and strong housing, with higher unemployment limiting the recovery in housing. GDP growth is likely to weaken and there will continue to be a big gap between business and consumer confidence – because consumers win from a high dollar but businesses, on the whole, lose.
The RBA’s plan for Australia appears to involve replacing the mining investment boom with housing.
It can’t get the dollar down because it’s in a currency cannon war with a popgun, but it can cut rates a lot more to at least get the housing market moving. And that’s what it will do.
In a long interview with the Australian Financial Review this morning, RBA Governor Glenn Stevens, left open the prospect of direct intervention in the currency, but focused more on interest rates and indicated that he was confident the housing market wouldn’t get overheated if rates came down further.
He said: "We don’t … rule out intervention as a matter of principle. It can be useful on occasions. Were it to be appropriate and useful, we’d certainly consider it, but we haven’t done so yet, and we’re unlikely to signal ahead of time, really an intent; but we certainly don’t rule it out under exceptional circumstances.”
The problem is that to do it, the RBA would be taking a big "negative carry” – that is, selling assets earning 3 per cent and buying foreign assets earning nothing – so for the moment it’s all about interest rates.
As to whether the RBA will keep cutting rates, Glenn Stevens said: "Look I don’t think there’s any particular totemic significance to be attached to going below 3 per cent if it needed to do that".
"Markets presently are pricing that, I’m not either going to seek to dissuade them or to encourage them in that view. We will have a look in the New Year and see how things look. But I think we have to recognise that we are in a very unusual world internationally. It is a very important conditioning factor that the rate of interest out of the global money centres is nil.
"A 3 per cent rate for us, which is very low by historical standards is, by global standards, pretty attractive for others. I think we have to recognise that and accept that that has some impact on where we set things.”
The problem with very low interest rates, as the US found to its cost, is that it can lead to a housing credit bubble. On this subject, Glenn Stevens said: "the classic problem in a situation like this can be that you seek to compensate for a very high exchange rate with cheaper, lower interest rates. That can – in some circumstances – give you the asset credit build-up that then gets you into trouble later".
"So we’re mindful of that, I don’t really think we’re seeing that though at the present time. We’ve seen some pick-up in housing prices, as you’d expect with interest rates coming down, but I don’t think we’re seeing at the moment a dangerous leveraging up there by households.
"…(it’s) a potential danger but I don’t think it is one which is being crystallised, at least not that we see at present.”
In predicting the lowest cash rate in history – 2 per cent – on Monday, ANZ’s Warren Hogan pointed out that making monetary policy (and overall policy) in Australia is becoming "increasingly difficult given continued global policy settings of zero interest rates in major regions and additional quantitative easing, which is keeping the US dollar weak and boosting the Australian dollar, even as Australian interest rates are reduced and Australian fundamentals weaken.”
In other words, whether it likes it or not, Australia is in a war. The world’s most powerful nations are sitting on zero interest rates and printing money to get their currencies down and there’s very little Australia can do about it.
Adding to the high currency is the political contest for a budget surplus in an election year (Why Stevens can bank on a budget surplus, December 19). The terms of trade have fallen about 15 per cent this year, which is reducing company tax revenue sharply.
The political pressure on the government to deliver a surplus next year is doing more damage to the economy in the short term, although it’s a good thing for the medium to long-term, and putting further pressure on the RBA to cut rates.
But even a 2 per cent cash rate is probably not, on its own, going to bring down the dollar when a 15 per cent drop in the terms of trade has already failed. After all, 2 per cent still looks pretty attractive compared to zero.
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