Aussie dollar to continue decline against US dollar?
Reserve Bank of Australia is walking a tightrope as it balances concerns about the housing bubble, the economy, interest rates and their effect on the Aussie dollar
The clouds over Australia’s economy have been gathering for at least 18 months and weighing heavily on the Aussie dollar. The darkest cloud on the horizon is the property market and a bubble that has been inflating for the last 55 years. Australians who have ridden the property boom have accumulated an extremely high level of household debt. However, this is just one of the factors the Reserve Bank of Australia (RBA) will weigh into its rate decision.
The cash rate (overnight borrowing rate banks charge each other) has remained static at 1.5% for the last 22 months. Most experts expect the RBA to hold that rate when committee members meet on Tuesday (August 7). The bank’s quarterly Statement on Monetary Policy follows on Friday when it presents economic growth projections.
One of their aims is to prevent persistently low inflation turning into deflation. That likelihood isn’t imminent, unless there’s significant economic downturn which would result in Australians hoarding money thereby contracting economic activity.
The standard response to inflation that falls below target for an extended period is to cut interest rates. But the RBA’s hands are hamstrung as they fear further fuelling the property bubble.
Another reason to avoid a rate cut is that it doesn’t leave the RBA with much room to play with. The lingering threat of an economic downturn leaves the RBA short of options if it must cut rates further.
These factors have contributed to the steady fall in value of the Australian dollar. The growing gap between Australian and US interest rates has resulted in a 5% fall against the US dollar this year.
AUSSIE DOLLAR IS FLAGGING
Heavily indebted Australian households are hoping the RCB doesn’t opt to increase rates in its effort to boost the flagging Aussie dollar. This has left the RBA walking a tightrope, and few options, while the US Federal reserve is free to move away from the zero-rate policy of the post-financial crisis period and get ahead of the inflationary cycle.
Tellingly, the Fed’s key cash rate target moved above the RBA’s for the first time in 18 years. The US’s economy is benefitting from stimulatory fiscal policies and has seen unemployment drop to its lowest in 50 years.
Given these ongoing pressures Moody’s forecast the Australian dollar weakening further against the US dollar.
“Further divergence in policy and consequently larger interest rate differentials between the US and Australia risk weighing more heavily on the Australian dollar,” say the authors of the Moody’s latest analysis Gene Fang and Allister Lim.
“Additionally, the split risks inadvertently raising inflation from currently benign levels, which may prompt the RBA to hike rates sooner than markets expect.”
“Sustained currency depreciation is credit negative for Australia because it could bring forward a tightening of the country’s monetary policy, making debt less affordable for highly leveraged households.”
EXPORTS HELP TO PROP UP AUSSIE DOLLAR
The Fed are expected to make five further rate hikes by the end of next year. However, export prices in iron ore and coal and have helped to prop up the Aussie dollar recently. Economists expect sustained demand for Australian commodities will prevent a steep drop in its value.
The Australian Financial Review surveyed currency experts in June. The consensus was that the Aussie dollar would end 2018 at US75c. Westpac’s currency experts expect the Aussie dollar to have dropped to US72c by June 2019. This suggests that local economists don’t expect further rates differentials to further affect the currency.
Could this be the moment the RBA decide that supporting the Aussie dollar is the higher priority? With next year’s Federal elections looming a rate hike would be hugely unpopular with highly leveraged mortgage holders. This convergence of factors could make this an ideal opportunity to short the Aussie dollar.
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