Reserve Bank unlikely to act on high dollar
When the Reserve buys the $A to defend it against selling, as it occasionally has in the past, there is a limit to its power. It needs to sell assets denominated in other currencies to free up funds for $A buying and its foreign currency reserves are finite. They currently sit at about $36 billion, 90 per cent of which is split evenly between US dollars and euros.
If the object is to drive it down, however, the Reserve has the equivalent of a bottomless cup: it controls the banknote printing presses, and can run them as hard as it pleases to underpin a sell $A-buy foreign currency strategy.
But it would be an adventurous leap from there to an assumption that the central bank is edging closer to an on-market attempt to drag down the value of the stubbornly strong $A. The Swiss have done it, but it's not a very useful precedent.
The Swiss franc is a go-to currency in times of uncertainty, and in 2011 as Europe's sovereign debt crisis swirled foreign money poured into it, pushing its exchange rate sharply higher. Switzerland's economy was being undermined, and in September of that year the Swiss National Bank announced that it was prepared to buy foreign currency in "unlimited quantities" to cap the exchange rate at €1.2.
Could Australia's central bank do the same? Yes. Will it? Unless there is a sea change in the Australian economy and the value of the Australian dollar, no.
The Swiss operation has been massive. Its foreign currency reserves rose by 62 billion francs to 314 billion francs in 2011, and by another 113 billion francs to to 427 billion francs last year. Its foreign reserves have also risen from below 10 per cent of Switzerland's annual gross domestic product ahead of the financial crisis to about 75 per cent of GDP. As Debelle remarked this week, a Reserve Bank intervention that had similar economic weight in this economy would top $1 trillion.
As Debelle also observed, the Swiss central bank was facing more extreme conditions in 2011 than the ones the Reserve faces today (or for that matter, faced in 2011).
First, the Swiss franc was more dangerously overvalued in 2011 than the Australia dollar is, or has been in recent years. The $A would need to be trading at $US1.30 or more to be in the same territory. It is about $US1.02 now after falling from just under $US1.06 in mid-January, and at that level is "somewhat on the high side", to use Debelle's words, and "somewhat higher than one might have expected" given a 17 per cent decline in Australia's terms of trade since the middle of 2011, to use the words Reserve Bank governor Glenn Stevens chose when he briefed the House of Representatives Economic Committee last week.
Second, Switzerland's economic growth had stalled in 2011, and the money that was pouring in from overseas was threatening economic disaster. The high $A is hurting parts of this economy, but the economy is still growing.
Third, Switzerland was battling price deflation, and still is. Its consumer price index has been in negative territory for almost a year and a half. There is no immediate risk that intervention will unleash inflation, as there would be here.
Finally, the Swiss National Bank only intervened after cutting its key short-term interest rate to zero. Its orthodox arsenal was exhausted: that is not the case here.
The Reserve has cut its cash rate six times by a total of 1.75 percentage points in the past 16 months and with the cash rate at 3 per cent still has room to move. It meets next Tuesday, and Stevens said last week that the exchange rate was one of the influences on the economy that it took into account.
Debelle said this week that quantitative easing in the United States and elsewhere was creating exchange rate pressures. QE stimulus was "understandable and defensible" in countries where interest rates had gone as low as they could, he said, but some of the QE cash was being reinvested offshore, pulling the home economy's exchange rate down and stimulating activity there, but pushing up on the exchange rates of countries such as Australia that are getting the investment inflow.
Lowering rates in the recipient countries was a response, Debelle said. It raised risks of excess credit expansion and accelerating inflation, but the Reserve had so far been able to counter the effects of a higher $A with lower interest rates and still had scope to cut further, for reasons that could include "counterbalancing" an elevated $A.
I would say that's a pretty fair summary of where the Reserve is at. It thinks the $A is higher than it should be, but it doesn't think it is at crisis levels. Quantitative easing and record low interest rates in key developed markets overseas have worked to hold its value up, but the first lever that is pulled in response to that is interest rates, and it is not yet fully extended. The Reserve could mount a Swiss National Bank-style intervention if it wished, and it could be a big one. As things stand, however, it doesn't need to.
mmaiden@fairfaxmedia.com.au
Frequently Asked Questions about this Article…
Yes — the article explains the RBA has the tools to intervene in currency markets. Its on‑market foreign exchange purchases are limited by its finite foreign reserves (about $36 billion), but it also has the capacity to underwrite a sell‑$A, buy‑foreign‑currency strategy by using banknote issuance. That said, the RBA currently views the A$ as higher than it should be but not at crisis levels, so large-scale intervention is unlikely unless there is a major change in economic conditions.
The article states the Reserve’s foreign currency reserves are roughly $36 billion, with about 90% split evenly between US dollars and euros. Those finite reserves limit the RBA’s ability to buy Australian dollars to defend it; the bank would need to sell other‑currency assets to free up funds for such operations.
In principle yes — Debelle said the RBA could mount a Swiss‑style intervention — but the article makes clear the circumstances are very different. The Swiss acted in 2011 amid far more extreme overvaluation, stalled growth and deflation, and after cutting rates to zero. Unless there is a sea change in Australia’s economy or in the value of the A$, the RBA is unlikely to follow that precedent.
The Swiss intervention was massive: foreign reserves rose by tens of billions of francs and reached a level that represented a large share of Switzerland’s GDP. Debelle noted that an intervention of comparable economic weight in Australia would top $1 trillion. Switzerland faced more extreme conditions in 2011 (greater overvaluation, stalled growth and deflation) than Australia faces now, which is why the Swiss model isn’t a directly useful template for the RBA.
According to the article, the RBA’s first lever is interest‑rate policy. The Reserve has cut its cash rate six times (a total of 1.75 percentage points over 16 months) and with the cash rate at 3% still has scope to move further. The RBA treats the exchange rate as one of the influences on the economy and prefers to use rate adjustments before large‑scale market intervention.
The article notes that QE in the United States and other countries has created exchange‑rate pressures: some QE cash is reinvested offshore and flows into countries like Australia, pushing the A$ up. The RBA has been countering that pressure with lower interest rates. For investors, that dynamic means global QE can lift the A$ and affect sectors differently (for example, export‑exposed businesses can be hurt by a stronger currency while importers and overseas travellers may benefit).
The article quotes Debelle saying the A$ would need to be trading around US$1.30 or more to be in the same territory as the 2011 Swiss franc overvaluation. At the time of the article the A$ was about US$1.02 (down from just under US$1.06 in mid‑January), which the RBA describes as “somewhat on the high side” but not at crisis levels.
The article highlights that a strong A$ is hurting parts of the Australian economy, though growth continues. Investors should be aware that the RBA sees the currency as higher than ideal but is more likely to use interest‑rate policy than immediate large‑scale FX intervention. That means currency strength, global QE flows and potential further rate cuts are factors to monitor when assessing exposure to exporters, importers and internationally sensitive investments.
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