Standby for a good, old fashioned current account scare as the Australian dollar continues to rise as it did last night in the wake of the Reserve Bank rate rise.
The dollar hit a new 14 month peak around 89.20 US cents as gold soared to a new all time high of $US1045 an ounce, thanks to a fall in the value of the US dollar (due in part to the RBA decision), but mostly to the strongly denied report in The Independent that oil producing states were pushing to drop the greenback as a pricing currency.
That report was by the strongly pro-Arab Middle East reporter, Robert Fisk and its fanciful nature brought a chorus of denials from Saudi Arabia and Kuwait (who were mentioned), plus other countries said to be involved: it had the self-serving effect of weakening the dollar and sending gold and other commodity prices higher.
And that helped push the Aussie dollar up to those new highs and closer to parity, a rate forecast for the next year by some economists, including the AMP’s chief strategist, Shane Oliver.
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We saw on Tuesday the damage the stronger dollar has done to the trade account, with the value of imports down (which will feed through into lower inflation, which the RBA would like to see) and lower export income (which is adding pressure to the fall already happening in exports because of the recession and the fall in the prices of iron ore and coal).
The RBA admitted that interest rates have risen for many borrowers because of higher fixed home loan rates and risk margins for business borrowers. It also admitted it prepared to wear the damage to the export account (or tradeables, as it termed them in the post meeting statement yesterday):
In addition, the exchange rate has appreciated considerably over the past year, which will dampen pressure on prices and constrain growth in the tradeables sector.
These factors have been carefully considered by the Board.
But Australia’s export income has shrunk by a third from its peak around October-November last year and by 25% since last September. The exchange rate a year ago was 88 US cents; it fell to an average of 66 US cents, and has rebounded this year. Currently it is up around a third from those lows.
The RBA has already warned that the terms of trade would worsen because of the slump and the downturn in prices, but it would seem from previous comments, it had been looking for the lower exchange rate to cushion that for a bit longer than it actually has.
Its own commodity price index for September revealed a 2.7% fall after a 0.2% drop in August.
TD Securities Global markets chief strategist, Stephen Koukoulas got stuck into the RBA’s decision for this very reason in an opinion piece in the AFR today.
He said the “glaring omission” from the RBA statement “was the specific mention of exports.”
With exports accounting for 20% of Australia’s GDP and the world economy an important element of the RBA’s more upbeat view, it was a curious point to gloss over.
Just hours before before the RBA lifted rates, the international trade data confirmed the news that Australia’s exports had collapsed, falling by more than a third from peak levels a year ago.
While the RBA noted the exchange rate had appreciated considerably, which will constrain growth in the sector, the free fall in exports must be one of the biggest risks to the RBA’s view.
On top of this, the RBA Governor conceded in his statement that there had already been a de-facto rate rise because of higher fixed home loan rates and risk margins on loans for business, plus the impact of the higher exchange rate.
Interest rates facing prospective borrowers on fixed-rate loans have already risen to some extent, as markets have anticipated a higher level of the cash rate.
For many business borrowers, increases in risk margins will still be occurring for some time yet.
Unemployment has not risen as far as had been expected. The weaker demand for labour over the past year or so nonetheless has seen a moderation in labour costs.
Helped by this and the earlier fall in energy and commodity prices, inflation has been declining, though measures of underlying inflation remained higher than the target on the latest reading.
Underlying inflation should continue to moderate in the near term, but now will probably not fall as far as earlier thought.
That’s the subtext for the decision: inflation wasn’t crushed by the slowdown because it was too shallow. Now we have to lift rates and use the appreciating exchange rate to do the job.
But the the core paragraph in the statement was:
In late 2008 and early 2009, the cash rate was lowered quickly, to a very low level, in expectation of very weak economic conditions and a recognition that considerable downside risks existed. That basis for such a low interest rate setting has now passed, however. With growth likely to be close to trend over the year ahead, inflation close to target and the risk of serious economic contraction in Australia now having passed, the Board’s view is that it is now prudent to begin gradually lessening the stimulus provided by monetary policy. This will work to increase the sustainability of growth in economic activity and keep inflation consistent with the target over the years ahead.
No mention of exports in those words. And yet we are supposed to be so hooked into the Chinese recovery and better conditions in economies like India, that it has saved the trade account from real damage.
Not on yesterday’s international trade figures.
We will have a chance to hear more detailed reasoning for the decision from Governor Glenn Stevens and two of his senior assistant Governors, Phil Lowe (economics) and Malcolm Edey (financial system) in speeches due later this month.