Heat Escapes From the Aussie Dollar’s Rally

• Heat Escapes From the Aussie Dollar’s Rally

This month’s Reserve Bank of Australia meeting was a lot more keenly watched than might be expected considering the overwhelming consensus that policy makers were going to leave the cash rate at a record low for a 12th month.

That interest had been fueled by intensifying speculation that rate hikes were soon to be on the menu Down Under and the resulting surge in the Australian dollar. RBA Governor Philip Lowe met, or even perhaps exceeded expectations by pushing back against both trends. Among the key comments in the RBA’s wordiest statement for more than four years, Lowe said the Aussie’s gain was “weighing on the outlook for output and employment.”

In money markets, rate-rise speculation also cooled, with traders stepping back after briefly putting the odds at a hike within one year at 100 percent. They are still expecting an increase, which may contrast with what Australia’s yield curve is telling us. The gap between three- and 10-year rates is often seen as an indicator of economic prospects, and the fact that it has stayed down could signal the sort of sluggish output growth that would keep the RBA on hold.

Something else to consider is the way the currency, and reduced inflationary expectations, may already have started to tighten conditions in the economy. The RBA recently estimated the new neutral cash rate — the level at which the borrowing benchmark is neither boosting or braking output — at 3.5 percent, which would indicate there’s a whole 2 percentage points worth of stimulus from the current setting at 1.5 percent. However, if you take into account market projections for inflation and the impact of a stronger Aussie, there may be just 1 percentage point of assistance at the moment.

The RBA’s currency dilemma certainly seems to be inflating the size of its statements if nothing else, a phenomenon that was apparent in 2012 and 2013 when the Aussie remained buoyant for some time in the face of interest-rate cuts.