The RBA blindsided everyone

Ian Waldie/Getty Images

The Australian dollar is comfortably back above US74c, having had a rocket set under it by the central bank’s statement on interest rates at 2.30pm Sydney time on Tuesday.

At US74.4c and rising in London’s opening trade at the time of writing, it is now not far from the level just over 75c it was at in early April when the monthly statement said: “Under present circumstances, an appreciating exchange rate could complicate the adjustment under way in the economy.”

Here we are, two months and a rate cut later, and the Aussie dollar is threatening to develop a spring in its step.

But this time the caution from the RBA – what’s referred to in markets as an “easing bias”, or a form of words in official communications that signals a rate cut is likely – simply isn’t there. In our round-up of reaction from some of the country’s leading economists today, they are all somewhat taken aback by this.

“Taking account of the available information, and having eased monetary policy at its May meeting,” the statement read, “the Board judged that holding the stance of policy unchanged at this meeting would be consistent with sustainable growth in the economy and inflation returning to target over time.”

In other words, the board saw 1.75% as about right.

If it was thinking of cutting further, typically it would say something like “further easing of policy may be appropriate over the period ahead”, as it did in March, signalling to markets that cuts to the cash rate were a live option. But not this time.

The problems with a higher dollar have not gone away: it stands on the throat of badly-needed inflationary pressures and risks inflicting some drag on sectors like tourism which have helped the economy deal with the hangover from the mining boom.

Just weeks ago many in the market believed a rate cut to a new record low of 1.5% was possible in the June meeting, and there was talk of a “structural break in flows” as analysts envisioned a scenario in which demand for Australian dollars fell dramatically.

So what gives?

Two important things have happened over the past week: expectations of an imminent rate hike by the US Federal Reserve have collapsed, and Australia turned in GDP data which showed that, at least in the first three months of the year, the economy was growing faster than pretty much anyone thought.

As Greg McKenna wrote this week, a detailed model used by the NAB currency team which factors in observable market prices such as interest rate differentials, commodities, and risk appetite, put the fair value for the Aussie at 0.7440 – almost exactly where it finished the Asian trading session.

That valuation is only valid for a certain period of time, as the different moving parts of the equation – global rates, commodity prices, and risk appetite – will shift in the coming weeks.

What is not in question is that where the Aussie goes from here is an important question for the economy.

The RBA signalled it is comfortable with current levels, with the statement noting that “the lower exchange rate overall is helping the traded sector”.

Too much of a rally, though, say back toward the 78 cent region we saw earlier this year, and some of that “help” begins to unwind.

For the moment most currency forecasters still think the Aussie’s rally is fragile and that it will ultimately fall again as China’s economy continues to slow and commodity demand drops accordingly.

But the nature of currency valuations is such that for the big falls forecast for the Aussie – the ones below 70 cents and toward 60 cents – a number of things need to happen. The Fed needs to raise rates, commodities need to fall, investor risk appetite needs to diminish – and the RBA needs to cut.

Unless any or all of these come true the Australian dollar could continue to defy what have been practically blanket expectations of a lower exchange rate.

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