The RBA's caution is an economic hazard

The Reserve Bank of Australia has once again made it exceedingly clear that they are happy to leave rates unchanged for the foreseeable future. But it faces a difficult balancing act between rising house prices and a stubbornly high dollar – two challenges it appears somewhat reluctant to tackle.

I noted after the board meeting on April that monetary policy was currently a dance between rising house prices, a stubbornly high Australian dollar and the impending collapse in business investment (Can the RBA have its cake and eat it?, April 1). Balancing those three factors poses a significant challenge for the RBA and a challenge that they have yet to get on top of.

Which is why it is interesting that the RBA placed relatively little emphasis on house prices and the exchange rate. For the housing sector, it notes that “housing market conditions remained strong, with housing prices rising in March to be 10.5 per cent higher over the year on a nationwide basis”. But it offers no other assessment.

In recent months the RBA has actively spoken out regarding house prices, reminding investors that prices can and do decline and that it would be uncomfortable if the sector generated further momentum.

But it has missed a number of opportunities -- in these minutes and in their board statement -- to drive the point home. That complacency could come back to haunt the RBA as speculation continues to run rampant on the east coast (Prepare for a sharp house price punishment, April 9)

On the exchange rate, the RBA elaborated a little more. It noted that “the exchange rate remained high by historical standards” and although commodity prices declined during the month, “the exchange rate had appreciated a little further”. Although the dollar has declined over the year, providing some assistance in rebalancing the Australian economy, the assistance is less than previously expected given the recent rise.

Over the past fortnight the Australian dollar has gone from strength to strength and is now almost 2 per cent higher than at the time of the board meeting. In part the appreciation reflects stronger economic data but it also reflects a high terms of trade, which is the biggest determinant of the exchange rate over the long-term. Until the terms of trade comes down, the Australian dollar is likely to remain high by historical standards.

Every additional month with a high exchange rate is putting more pressure on Australia’s vulnerable tradables sector. It’s reducing business investment and leading to job cuts across trade-exposed industries. A stubbornly high dollar has increased the probability that the non-mining sector will not be ready to fill the void left when mining investment collapses.

The RBA expects the unemployment rate to “edge higher for a time”. More timely data suggests that the unemployment rate declined to 5.8 per cent in March (from 6.0 per cent) on a seasonally-adjusted basis. However, as I argued last week, that number fundamentally overstates the improvement in labour market conditions since the participation rate declined by an equal amount (The truth about unemployment in Australia, April 10).

More reliable trend estimates of the labour market suggest that there was no improvement in March and, given the recent volatility regarding the labour force sample, these are the estimates that the RBA will focus on. Consequently, it is unlikely that the March data will shift the RBA’s view on the labour market -- and rightly so.

The RBA has made it clear that rates will not change in the near-term. With mining investment set to deteriorate and sharp budget cuts looming, that seems like the right decision. But I’m concerned that they may have become a little complacent regarding the high dollar and overheated housing market.

While balancing the two is difficult -- stemming house price growth may necessitate higher rates, while lowering the dollar requires lower ones -- the RBA seems happy to sit back and hope that the economy stays on track.

With each passing day, the high dollar is compromising the RBA’s vision of a rebalanced economy, potentially leaving the economy vulnerable when mining investment eventually falls in a hole.