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Reserve Bank of Australia buoyant on rates

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Reserve Bank of Australia buoyant on rates  article image

Currency market update 22 February 2011

Event

Recent commentary from the Reserve Bank of Australia (RBA) reveals a buoyant outlook on the Australian economy. Both Glenn Stevens’ parliamentary hearing and the release of the RBA board meeting minutes have contributed to ongoing positive sentiment of Australia’s economic strength, relative to other countries in the wake of the global financial crisis. The RBA also virtually confirmed there would be no short-term increases to interest rates with rates on hold until the middle of the year. This will be a key driver of the AUD in the ensuing period and with certainty about interest rates there are unlikely to be major short-term upward movements in the dollar given the market has already priced in an interest rate rise later in the year.

Impacts

RBA boss Glenn Stevens has told a parliamentary hearing in Canberra that he does not expect rates to increase in the near future and that current rates are suitable for the present economic environment. This, coupled with the release of the RBA’s minutes last week, led to the market concluding that rates will be on hold for the first half of this year with one or possibly two rate hikes to follow in the second half. Travelex is of the opinion that this hold on interest rates reflects a degree of political diplomacy on the part of the RBA, given the recent spate of natural disasters plaguing Australia’s east coast has resulted in a series of price shocks and a rate rise on top of this would be unpopular. However, with the terms of trade figures expected to peak higher and later than expected there continue to be strong signs of the robustness of the Australian economy. The RBA boss’ commentary on the Australian economy emboldened speculation that interest rates will be on hold until mid year or possibly longer. The strength of the Australian economy is further highlighted by trade data released early last week showing stronger than expected levels of Australian imports and exports with China. While this view is shared by many analysts, the market is divided on whether there will be one or two rate hikes this year. This discrepancy is potentially significant because of the uncertainty of the extent to which future rate hikes have been fully priced in by the market.

Considerations

While interest rates are likely to remain stable in the short term, the likely future hikes in interest rates will create upward pressure on the AUD. However, with one rate increase already priced in by the market for this year, the real action on the dollar will follow a second rate rise which will inevitably push the dollar higher. External factors, such as economic improvements overseas, especially the somewhat unexpected strength of China’s economy in recent times, means the AUD’s relative strength over many trading economies will be subdued in the next six months. We expect this to effectively counteract any upward trend on the currency resulting from a second rate rise later this year. Watch for improvements in the Chinese and major European economies in the next few months as these are likely to be the main drivers of the AUD’s direction. Continued improvements in the major global economies will push the dollar lower, though Australian exporters will see little short-term relief from historically high trading ranges see in the last few months. -Anthony Gray is the Head of Client Management, Northern Region, Travelex (www.travelexbusiness.com.au/).

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