The Australian dollar will play a crucial role in determining what the RBA will do next

LUKE FRAZZA / AFP / Getty Images
  • The RBA just provided financial markets with a subtle reminder on the importance the Australian dollar plays in determining domestic monetary policy settings.
  • The weaker Australian dollar has helped Australia’s trade-exposed sectors this year, contributing to an acceleration in broader economic growth.
  • It has been likened to a “shock absorber” for the Australia’s trade exposed sectors, helping to curb economic activity when times are good and make Australia more internationally competitive when activity is weak.

If the global economy was to suffer a sudden shock, and therefore change the outlook for the Australian economy as a consequence, many suspect the first course of port of call would be for the Reserve Bank of Australia (RBA) to adjust Australia’s cash rate.

However, whether any action is required at all will largely be influenced by subsequent reaction in the Australian dollar.

Here’s an interesting section from the RBA’s November meeting minutes released today. Our emphasis in bold.

Members discussed how different scenarios could affect the monetary policy decision, noting that the appropriate policy response would depend on the specifics of the situation, including the underlying factors driving economic developments. For example, in the event of a marked change in the strength of the global economy, the effect on the Australian economy – and thus the appropriate monetary policy response — would depend on any associated move in the exchange rate of the Australian dollar. Members also discussed various scenarios related to the labour market and household expenditure.

Essentially, before adjusting the cash rate, the RBA will assess whether the Aussie dollar has already done its job for them, acting as a shock absorber for the economy as it has done so many times in the past, including this year

Right now, the risks for the global economy, and hence Australia given it’s a smallish open economy, appear to be slanted to the downside.

Should global economic growth slow quite sharply in the coming year, including in China, the RBA will be hoping the Aussie dollar will continue to weaken, helping to reduce the need to cut the cash rate again which it clearly doesn’t want to d

However, should the Australian dollar strengthen during such an episode, an unlikely scenario but not unfathomable, that will make it difficult for the RBA not to act given the double-whammy it will deliver to Australia’s trade exposed sectors.

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