Australian central bank not interested in intervention

by Mark Benson on February 24, 2012

in Money, Business and Finance

Will the Aussie Dollar continue to rise?

Glenn Stevens, the governor of the Australian central bank, has today issued a statement revealing that the bank has no plans to intervene in the currency markets where the Australian dollar has been soaring for some time and is beginning to hit local industries. There were hopes that the Reserve Bank of Australia would intervene in order to try and control the runaway exchange-rate which is starting to have a major impact upon trade driven industries such as steel makers and car manufacturers.

Why is the Australian dollar so strong?

There are a number of reasons why the Australian dollar is so strong and why it is likely to remain naturally strong for some time to come. These include: –

Relatively high base rates

Base rates in Australia are currently 4.25% which is well above those in the UK and US which are minimal as overseas central banks attempt to refloat their own economies. As a consequence, international investors have obviously been attracted by the base rate in Australia which has led to an influx of money and a strengthening of the Australian dollar. While it looks like a reduction in base rates is unlikely sometime in the near future it is also worth noting that base rates in Australia are a long way off rates in the UK, Central Europe and North America. As a consequence, this particular factor which is affecting the exchange rate is likely to continue for some time to come.

Strong economy

The rise and rise of the Australian economy over the last few years has been phenomenal to say the least. Those who remember the recession in 2007/8 will also remember that Australia was the first developed economy to the pull away from the recession and this underlying strength has continued up until today. While there are signs that growth may be slowing, due to financial issues overseas, there is no need to panic as yet as there is still plenty of scope for further economic growth in the short to medium term. Perhaps the only downside with regards to the Australian economy at the moment is the struggling export arena which has for many years been a major plus point for the economy.

Investors like Australia

It is only now starting to become apparent that Australia is taking on the mantle as something of a “safe haven” during these difficult economic times. While many corporate markets around the world are struggling to raise finance for takeovers and mergers we have seen a number of Australian companies looking to expand overseas and take advantage of the current economic outlook. It seems that investors are more than willing to fund both domestic and international investment for a whole host of Australian companies and government bonds have also attracted the attention of overseas investors. Again, this is likely to continue in the short to medium term with the European financial problems far from over and the US economy struggling to pull away from a potential second stage recession.

Are there any potential flies in the ointment?

Both in relatively and in absolute terms, there is no doubt that the Australian economy is one of the strongest in the world and will continue to perform better than most in the short to medium term. However, there are a number of potential problems on the horizon which include: –

Difficult international credit markets

Despite the significant growth of the Australian economy over the last few years, Australian banks and Australian businesses still rely heavily on overseas credit. As a consequence, there is significant exposure to overseas credit markets which are struggling at this point in time due to the financial difficulties of European and North American banks. So even though the underlying strength in the Australian economy is there for all to see this may be impacted in the short to medium term if international credit markets were to dry up and cut off a vital supply of funding to Australian operations.

The outlook for the worldwide economy

Even though economies in the Far East and South America are performing very well compared to their European and North American counterparts there is no doubt that ongoing problems within Europe and North America will eventually impact the worldwide economy. There are many who hope that the problems in North America and Europe are coming to a close but there are also many who believe we have just reached the tip of the iceberg. There are funding issues with regards to international banks, there are funding issues with regards to government budgets around the world and slowly but surely we are seeing a return to very tight credit markets. Unless the Greek issue is resolved once and for all, with many unsure whether the recent announcement of a deal will hold, the euro will be dragged further down and the European economy will struggle.

Conclusion

The announcement by the Reserve Bank of Australia in relation to interest rates is in itself very buoyant and very bullish. In effect the authorities are suggesting that the Australian economy is performing well, there is no need to adjust the currency rate as yet and the natural growth within the Australian economy is set to continue. However, there is no doubt that if the Australian currency continues to strengthen in international money markets then at some point the authorities will have to intervene. So how will they intervene?

The most effective way of intervening would be to reduce base rates which would make direct investment in Australia less attractive for overseas investors looking towards government bonds, etc. However, there is a chance that such a move would fan the flames of inflation and indeed could lead to a raft of cheap credit becoming available to consumers and businesses. There is then the chance that the economy could overheat, inflation could eat into economic growth and the whole house of cards, which is Australia, could come tumbling down.

As a consequence, in the current unique economic circumstances it would seem likely that the authorities, should they wish to intervene and reduce the exchange rate, would arrange a systematic selling of Australian dollars both in Australia and with their overseas counterparts. This would then see selling pressure in international currency markets and hopefully the exchange rate would fall and exports would become more attractive.

However, we are far away from any major problems for the Australian economy and discussions regarding the “manipulation” of exchange rates are premature.

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