RBA Assistant Governor Christopher Kent gave a somewhat “academic” speech this morning, as Annette Beacher, TD Securities Head of Asia Pacific Research described it.
The speech focused on the relationship between the dollar and mining and resources and into the “the real equilibrium exchange rate”.
It was very wonkish but there seemed to be two key messages that Kent, and by extension the RBA, wanted to get out to the market.
The first was that the Australian economy still needs a lower dollar to balance out growth.
The Bank has noted for some time that lower levels of the exchange rate, if sustained, will assist in achieving balanced growth in the economy and bring about a quicker return to trend growth.
And the second, like the RBA’s recent Statement on Monetary Policy, was that inflation has spiked higher than expected as a result of recent falls in the Aussie dollar but that “it is still expected to remain consistent with the inflation target”.
Dealing with the more wonkish elements of the speech Kent noted that the relationship of the RBA’s Aussie Dollar TWI model (which is a terms of trade and interest rate based model) was fairly stable through time which prompted the ANZ strategy team to note that “the RBA continues to expect the value of the AUD to decline.”
But a model is just that – a model of the future, not the future itself. Kent also noted there had recently been periods of implied overvaluation and as a result, “on a number of occasions over the past 18 months or so the Bank pointed to the high level of the exchange rate, noting that it had not declined in response to changes in these fundamental determinants”.
However the flip side, according to Kent, is that the model might be now, or certainly in the future when LNG production really ramps up, overstating the Aussie dollar’s value because exports like LNG won’t see as much of the dividend from production accrue to Australian residents (in the form such as wages) but rather their foreign owners.
The ANZ says this implies “that the AUD may trade below the RBA’s model equilibrium level in the future.”
Currency forecasting, it seems, is a difficult prospect, even for the RBA.
The Aussie dollar initially dipped 20 points to 0.9066 but has since recovered to be trading at 0.9010.
Disclaimer: Greg McKenna is an active currency trader who agrees with the RBA that the Aussie should be lower and is short and wrong the Aussie dollar at the moment.