Currencies | Oct 05 2011
– RBA softens stance on rate cuts
– Stronger US dollar trend to continue for some months
– Combination of stronger greenback and RBA rate cuts negative for Aussie dollar
– CBA suggests Aussie dollar could dip below US90c
By Chris Shaw
In the view of Commonwealth Bank, commentary yesterday by the Reserve Bank of Australia (RBA) indicates a softening of previous resilience to keeping interest rates at current levels. This implies an increased risk of a rate cut.
As CBA chief currency strategist Richard Grace notes, the RBA view on rates has softened following downward revisions to global growth and because recent data suggest the underlying pace of price increases has not been as sharp as initial indications.
Grace points out the RBA view on the inflation outlook is now more consistent with its 2-3% target in 2012 and 2013. Assuming an improved inflation outlook, this offers the RBA increased scope for monetary policy to offer some support to demand if such a move becomes necessary.
For Grace, the risks of a near-term RBA rate cut have increased significantly. This suggests if equity markets continue to struggle and economic data from Europe and the US remain poor, the 3Q CPI number for Australia out later this month will be a key factor in any rate cut decision. A rate cut would put downward pressure on the Australian dollar.
Current strength in the US dollar is applying downward pressure to most currencies, the Australian dollar included. In Grace's view there are a number of reasons why the US dollar should remain firm for some months, one being the greenback typically rises any time there is increasing risk of a US recession. This is because risk averse investors look to pace capital in the US bond market as it is the world's most liquid bond market.
As well, Grace notes global bond yields tend to fall more than US bond yields, which increases the relative attractiveness of US bond spreads and generates buying of US dollars as investors shift money into US bonds.
With US residents large offshore equity investors, a weaker outlook for the US economy suggests weaker offshore equity markets and so causes a repatriation of capital back into US dollars. This flow of money is potentially significant, Grace noting US residents hold around US$8.9 trillion in offshore equity markets.
Grace also notes European banks have US dollar liabilities that require US dollar funding to cover, which means consistent demand for the greenback in global markets. Finally, Grace points out following a decade of the US dollar being in a downtrend there is now evidence of some reversal of short positions in the greenback.
Adding together a strong US dollar and increased risk of a rate cut in Australia leads Grace to suggest there is further downside potential for the Australian dollar. Short-term Grace sees scope for the currency to temporarily fall below US90c over the next month or so.
By year's end Grace expects a recovery in the Aussie dollar as the outlook for Asian economic growth remains reasonable and commodity prices are not expected to experience any further significant falls. This implies relatively good growth in Australia and relatively high Australian interest rates, even if the RBA cuts the cash rate to support demand.
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