The sum of all our dollar fears...

Concerns about the currency are overblown, considering its meaningful fall over the last six months. In fact the Reserve Bank has good reason to relax.

Reserve Bank governor Glenn Stevens is probably as worried about the recent movements in the Australian dollar as he is about the winner of the rugby league and AFL grand finals in the next few weeks.

Well, maybe he is a little more interested in the Australian dollar movements, but the recent spike above US 95 cents is unlikely to be a major headache for the Reserve Bank, given it is largely a function of a weaker US dollar, an upswing in commodity prices and signs that the domestic economy is about to lift to an above trend growth rate.

In the last couple of days, the Australian dollar actually fallen against the British pound and the New Zealand dollar, it’s been pretty stable against the euro and Korean won and has risen sharply against the US dollar and Chinese yuan.

After reaching a high of US95.35 cents yesterday, it has dropped back to US94.45 cents this morning as global financial markets come to terms with the policy fallout from the US Federal Reserve’s decision to maintain its extremely large bond buying program (The man with the golden gun, September 19).

The net effect of all the ups and downs in the Australian dollar is a rise of about 1.5 per cent on a trade weight basis compared with the level of the start of the week and a cumulative 4 per cent appreciation from the low point last month. In a bit more context, on a trade weighted basis, the Australian dollar is still a hefty 10 per cent or so down from the level of April. This is still a meaningful fall over less than six months.

A critical reason why the Reserve Bank and Governor Stevens are likely to have an agnostic approach to the recent Aussie dollar rise is that circumstances the usually drive its value have been changing.

Commodity prices as measured by the Reuters/Jeffries CRB index have risen by more than 5 per cent, in US dollar terms, from the June low. Something is underpinning this move, with a prime suspect being better economic news from the large economies of the world, especially China. The link between commodity prices and the Australian dollar is well understood and has been established over the 30 years the currency has been floating. A rise in commodity prices should mean that the economy can cope with a higher exchange rate. 

Another element of the stronger Aussie dollar and the relatively relaxed position of the Reserve Bank is the build-up of evidence that the economy is performing a little more strongly than feared a few months ago. Stronger global conditions are important in this, but domestically too there has been a run of quite favourable news, especially in what might be termed the leading indicators.

Consumer sentiment and business confidences have both jumped in recent months and while it is early days for this new-found optimism in the economy, the recent trends suggest higher spending from consumers and more favourable trading conditions for business in the months ahead.

At the same time, housing construction and house prices are on the rise. The transition from the mining investment boom to more domestically focused parts of the economy is continuing to unfold, which suggests a stable to slightly high Aussie dollar in recent times is more likely to be good for inflation and less of a concern for the growth outlook.

The Westpac-Melbourne Institute leading index itself, released during the week, was a strong 4.1 per cent in July to be well above the long-run trend of 2.9 per cent. The economy is doing just fine. 

The Reserve Bank has signaled a preference, in a way, for the Australian dollar to be lower. It would certainly support export growth and help the local import-competing industries. But hoping for a lower currency is not necessarily a sign of concern that its recent move of only a few percentage points after all, is creating problems in the economy. Those suggesting the Reserve cut interest rates because the currency is a little strong are ignoring the effects such a move would have on the already improving interest rate sensitive parts of the economy.

And who knows, the dollar might fall back soon if the US Federal Reserve comes out next month and starts to scale back its bond buying program. If that is the case, the public anguish over recent days will have been about nothing.

The Reserve Bank knows this and that is why it is looking forward to the premiership wins of South Sydney and Hawthorn.

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