Impact of 'volatile' Australian dollar on RBA interest rate cuts: 'Unusual'

Yahoo

2 days ago

The Reserve Bank of Australia (RBA) has noticed the Australian dollar isn't behaving the way it normally does during periods of global uncertainty. It said it will be keeping a close eye on it just weeks ahead of it meeting again to set interest rates.
The Aussie dollar plummeted after Trump's liberation day announcement, dropping to below 60 US cents. But, it has now rebounded, sitting between 64 and 65 US cents and rising above 65 cents overnight.
The Motley Fool's chief investment officer Scott Phillips told Yahoo Finance we were seeing global volatility for almost all currencies due to the uncertainty surrounding the long-term impact of Trump's tariffs.
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'Currencies are always volatile, but the market is trying to work out a few things at once,' he said.
'One is the likely future of the economy. The second is the likely future of the stock market and therefore the bond market. And as a result of all that, work out how much the currency is worth.
'That's why it's so difficult because there are so many moving parts and things are changing so rapidly. That's why you see a lot of whip soaring.'
RBA assistant governor Sarah Hunter said the Aussie dollar had been behaving differently against the greenback than expected.
'When the outlook for global growth weakens, the Australian dollar typically depreciates as investors expect our economy to be buffeted by the global headwinds and the RBA to respond with cuts to the cash rate,' she said in a speech at the Economic Society of Australian Business Lunch this week.
The fact that the Aussie dollar is a 'risk-sensitive' currency also contributes to the depreciation, with global investors tending to focus on reducing risk exposure and moving capital to low-risk assets in countries like the US, Switzerland and Japan when they are worried.
'While the initial response of the Australian dollar during the current episode was in line with historical experience, the recent recovery against the US dollar in particular has been more unusual,' Hunt said.
Hunt said this was partly due to weakness in the US dollar.
"We'll be monitoring how these channels play out over time,' she said.
The RBA can influence the exchange rate using interest rate decisions and interest rate decisions are also impacted by the dollar, Phillips said.
The RBA can also buy and sell Australian dollars in the open market to influence the exchange rate.
'On the flip side, they may choose to move rates because of where the currency is, if they want to impact the level of the currency and they will generally only do that at extremes,' Phillips said.
'Their preference is to let the currency float and find its own level because markets generally get this right and if the market is determined to move a currency one direction or another, there's so much money in private capital markets, it's incredibly hard for a central bank to stop that.'
Phillips said the RBA in the short-term wants stability of the currency because the more stable it is, the more confidence individuals and businesses have within Australia, and in dealing with the Australian dollar.
'If you're not sure where the currency is going to be, you tend to be less likely to want to trade it or invest in it, or buy from it. That can impact the broader economy because it impacts our imports and exports,' he said.
Phillips said the RBA cared about currency, but would be putting more weight on the health of the economy, inflation and the potential impacts from the global economy.
Economic growth was weaker than expected in the March quarter, with the economy growing just 0.2 per cent, down from 0.6 per cent in the December quarter.
Economic activity increased by just 1.3 per cent over the year to March. The RBA had forecast annual GDP growth of 1.8 per cent by the end of the June quarter.
Australia's annual inflation rate was 2.4 per cent in April, unchanged from the previous quarter. Underlying inflation edged higher to 2.8 per cent, up from 2.6 per cent in March.
'The currency matters to the extent that impacts happen in the broader economy. The biggest impact of the dollar is trade flows,' Phillips said.
'If the dollar is lower, it's great for our exporters because it makes Australian products more competitive on the international market, and it's bad for our importers and it is also bad for inflation.
'A higher dollar is worse for our exporters because it makes Australian products less competitive, but it is better for our importers and it's better for inflation.'
Phillips said the RBA would be wanting stability and if it feels like currency is massively overvalued or massively undervalued then it would take action, but usually not by rates alone.
'More often than not, their direct intervention tends to be buying and selling Australian dollars," he said.
"But rates will be part of that story, if they believe that moving the interest rate can impact the currency without having deleterious effects on the physical economy itself."
Market pricing on the chance of the RBA delivering another 0.25 per cent cut at its July meeting increased from 74 to 81 per cent following the national accounts data yesterday.Sign in to access your portfolio