The head of the international division at the Reserve Bank of Australia (RBA) said on Wednesday that there is a lot of uncertainty about where neutral interest rates are and where they are headed.
Key quotes
There is a lot of uncertainty about where neutral interest rates are, and where they are headed.
Australia’s neutral interest rates may also be affected by global factors, and may have risen since the pandemic.
On top of compressed equity risk premia, credit spreads mean financial conditions in Australia have been easier than ever this year.
Concerns about the US dollar’s safe-haven status appear to be overblown, at least for now.
There is little evidence of significant reallocations away from US dollar assets.
We must be prepared for possible episodes of volatility and possible turmoil in the market.
Market reaction
AUD/USD is adding 0.42% on the day to trade at 0.6495 at press time.
RBA Frequently Asked Questions
The Reserve Bank of Australia (RBA) sets interest rates and manages Australia’s monetary policy. Decisions are made by the Board of Governors at 11 annual meetings and ad hoc emergency meetings as needed. The RBA’s primary mandate is to maintain price stability, which means an inflation rate of 2% to 3%, but also “to contribute to currency stability, full employment, economic prosperity and the well-being of the Australian people.” The main tool for achieving this is raising or lowering interest rates. Relatively high interest rates will strengthen the Australian Dollar (AUD) and vice versa. Other RBA tools include quantitative easing and tightening.
While inflation has always been thought to be a negative factor for currencies because it reduces the value of money overall, the opposite is the case in modern times with the relaxation of cross-border capital controls. Moderately high inflation now tends to prompt central banks to raise interest rates, which in turn attracts more capital flows from global investors looking for a profitable place to keep their money. This increases demand for the local currency, which in Australia’s case is the Australian dollar.
Macroeconomic data measures the health of an economy and can have an impact on the value of its currency. Investors prefer to invest their capital in safe and growing economies rather than unstable and shrinking economies. Greater capital inflows increase aggregate demand and the value of the local currency. Classic indicators, such as GDP, manufacturing PMIs, services, employment and consumer opinion surveys can influence the Australian dollar. A strong economy may encourage the Reserve Bank of Australia to raise interest rates, which will also support the Australian dollar.
Quantitative easing (QE) is a tool used in extreme situations when lowering interest rates is not enough to restore the flow of credit in the economy. Quantitative easing is the process by which the Reserve Bank of Australia (RBA) prints Australian dollars (AUD) for the purpose of purchasing assets – typically government or corporate bonds – from financial institutions, thus providing them with much-needed liquidity. Quantitative easing usually leads to a weaker Australian dollar.
Quantitative tightening (QT) is the opposite of quantitative easing. It is implemented after quantitative easing when the economic recovery is underway and inflation begins to rise. Whereas in QE, the Reserve Bank of Australia (RBA) buys government and corporate bonds from financial institutions to provide them with liquidity, in QT, the RBA stops purchasing any more assets, and stops reinvesting the capital owed on the bonds it already holds. It will be positive (or bullish) for the Australian dollar.
