The dollar rolls away from the RBA

The Reserve Bank appears to be targeting a lower dollar, but with commodity prices nearing record highs and the economy set to be well on track next year, a strong currency isn't necessarily bad.

The Australian dollar has surged in recent days and this morning is trading at around 91.7 US cents, against most expectations in the market.

Reserve Bank Governor Glenn Stevens reckons that forecasting the level for the Australian dollar is a mug’s game. From time to time the RBA staff make estimates as to fair value of the currency, but it seems that often these estimates are no better or worse than most forecasts doing the rounds in financial markets – and that is not an endorsement of the track record of the bank.

It still appears to be the case that the Reserve Bank is struggling to work out fair value for the Aussie dollar – and therefore this still might be feeding into its overall assessment of where the economy currently is, which in turn will have some influence on its assessment for monetary policy settings.

It is curious that in his statement on Tuesday, where Stevens said “it is possible that the exchange rate will depreciate further over time, which would help foster a rebalancing of growth in the economy”, there was an interpretation from some that the Reserve Bank wanted the currency to fall. This is probably a fair interpretation.

But why would the RBA go out on a limb and suggest a lower Australian dollar was desirable in the current economic climate?

Commodity prices have moved higher in the past few months (A commodity cure for economic ills?August 14). The Reserve Bank’s own index shows a 1.8 per cent rise in prices in SDR dollar terms in the last two months. Since November 2012, the Reserve Bank index of commodity prices in Australian dollar terms has risen a hefty 14.5 per cent to be at a 15-month high.

What terms of trade slump?

Commodity prices in Australian dollar terms are now just 13 per cent from a record high and are 135 per cent above the low point for commodities back in 2002.

Why would the RBA want the Aussie dollar lower in these circumstances, especially as it has already fallen by around 15 per cent in the past six months?

I suspect the central bank is being slow to see turning points in global economic conditions, much like it was in 2011 and 2013 when it dragged the chain on recognising the end of the mining investment boon, the dip in the terms of trade and the harm the over-valued dollar was inflicting on general economic conditions.

Indeed, for those looking at the current sub-trend rate of economic growth and the lift in the unemployment rate, the Reserve Bank should be in focus for this policy tardiness.

But things are now changing. In August, with the last rate cut to 2.5 per cent, the central bank finally caught up to the requirement for easy monetary policy. That is good news. When the Reserve Bank gets it wrong, it doesn’t stay wrong for too long. That is one of the virtues of monthly meetings of its board.

With the economy seeing a decent lift in growth and on track to return to an expansion well above trend as 2014 approaches, the central bank is obviously done and dusted with rate cuts (The rate cut dash is done and dusted, September 3). The interest rate hiking cycle is likely to start in the early months of 2014 and it would be no surprise to see 100 or even 150 basis points of rate hikes during 2014.

This is because the current spare capacity in product and labour markets will quickly be absorbed, while a likely consolidation in commodity prices and booming export volumes will underpin large and growing international trade surpluses.

With the budget surplus coming rapidly down the pike, there will be no threat to our triple-A credit rating, and global funds are likely to flow back into high-yielding Australia and the Australian dollar.

While some industries will again be caught in the afterburners of a stronger currency, more favourable global economic conditions, solid economic growth domestically and some stirring in inflation pressures will be evident. A strong Australian dollar will not necessarily be a bad thing.

That the Reserve Bank is citing the stimulatory impact of a lower Australian dollar is something of a truism. If it falls, growth and inflation will be higher. But that is only tolerable if the economy is locked in at a below-trend pace and inflation is fly-papered to the bottom of the target range.

That is no longer looking like the scenario for the next 12 to 24 months.

Maybe the Reserve Bank should have another look at its Australian dollar models, which right now would make it aware that there is a very real risk that the currency will be climbing back to parity in 2014.

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