Does the RBA really want a lower Aussie dollar?

The Reserve Bank has just been presented with the perfect opportunity to again talk the Australian dollar down. But inflationary pressures arising from a lower dollar could be a bigger concern.

With the Aussie dollar having traded at its highest level in 2014 overnight the RBA has the perfect opportunity this week to try and talk it down again. I will be interested to see if they will or instead allow it to pass by without comment on the currency. Central bank officials, namely Governor Glenn Stevens and Deputy Governor Philip Lowe are both scheduled to speak this week, and with the dollar at elevated levels it seems an ideal time.

The absence of comment however would be akin to acknowledgement that they may have lost the battle to talk it down or, more likely, they are now concerned about higher import prices adding to inflationary pressures.

The RBA has been quite vocal about the negative effects of a higher Australian dollar but is it now in the process of shifting the debate in the other direction? The first step in the shift may have already begun with a softening of the rhetoric from an “uncomfortably high” Aussie dollar to a “historically high” one.

If the increase in inflation from the tradables sector continues they may be coming at us from the opposite perspective by year end, talking about the negative effects of a lower Aussie dollar. It might just be a case of “be careful what you wish for” in regards to the currency with the recent falls adding to inflationary pressures in an already heated domestic economy.

The Reserve Bank may have been caught by surprise how quickly the drop in the Aussie dollar has fed through to what’s sometimes referred to as import price inflation. A lower Aussie dollar serves to increase import prices hence adding to inflationary pressure in the tradables component. While most people focus on the headline CPI number and where it sits in relation to the RBA's 2 percent to 3 per cent  band, it is important to distinguish between domestic inflation versus imported inflation. This is especially significant since around 40 per cent of the goods used by the ABS to measure CPI have prices determined externally, on global markets, not domestically. 

Graph for Does the RBA really want a lower Aussie dollar?

As is evident in the RBA's chart above, lower or negative import price inflation (RHS) has helped to offset high domestic inflation (LHS) that has been hovering around the 4 per cent level since the onset of the GFC.

Should the recent trend continue, the RBA may be forced to raise rates to curb domestic inflationary pressures and at the same time keep a lid on import price inflation. Such action would of course send the Aussie dollar higher but I get the sense the central bank might not be as upset by that scenario as many might think.

Jim Vrondas is Chief Currency strategist, Asia-Pacific at OzForex, a global provider of online international payment services and a key provider of Forex news. OzForex Group Limited, is a publicly listed entity with shares traded on the Australian Securities Exchange under the code "OFX".

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