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Speculation mounts over RBA intervention to cap AUD strength

Reports in the Australian press that the Reserve Bank of Australia (RBA) has been urged to intervene to suppress the strength of the AUD are unlikely to be heeded.

According the Australian Financial Review, officials from other central banks have told the RBA that if it wants to drive down the value of the AUD, it should consider large-scale intervention rather than cutting interest rates. Buying from reserve managers, who meet this week at a conference hosted by the RBA in Sydney, has been one of the main driving forces behind AUD strength in recent years.

Concerns that the ultra-loose monetary policy pursued by other central banks, such as the Federal Reserve and the European Central Bank, are undermining the value of their currencies has prompted reserve managers, especially in Asia, to consistently add to their official AUD holdings.

Indeed, despite a recent move from the RBA to cut rates to 3%, AUDUSD has broken up through $1.05 for the first time since September as the Fed introduced a fresh round of quantitative easing.

The AFR points out that the idea of intervention is not foreign to the RBA, especially since the bank’s deputy governor, Philip Lowe, recently said that “very low interest rates in many other economies should not be seen as a good thing or something to aspire to.”

 Investor love affair with Australia: foreign official holdings
 of public debt by country (% of total public debt) 

 Source: Arslanalp & Tasuda (2012), ANZ

However, Steve Englander, head of FX strategy at Citi, describes the notion of other central banks urging the RBA to intervene as “like the fisherman explaining the benefits of his fishing net to the fish.”

“The problem for reserve managers seeking to diversify is that there are not enough good assets to buy,” Englander says.

“From their perspective, the RBA selling a truckload of AUD would be a welcome source of AUD supply. If the intervention were sterilized, it would essentially be the RBA taking AUD assets from domestics and selling to foreigners.”

Englander says from the RBA’s perspective, it does not look so appealing, given that reserve managers will be selling USD and, to a lesser extent, EUR and JPY.

“The RBA would be getting in return a basket of loser currencies,” he says. “The RBA’s side of this transaction does not look attractive.”

Of course, the motivation for intervention is to avoid cutting rates, which may distort domestic asset markets and lead to excess credit creation and unsustainable domestic bubbles.

This, according to Englander, is a correct argument and may be part of the reason that more central banks whine about currency strength than act on it.

“Overall we think, however unhappily, central banks will tolerate more appreciation because appreciation can be reversed quickly if conditions change, rather than create an unsustainable domestic asset market boom, which as we have discovered can be hard to reverse,” he says.

For the time being, it looks like the world’s reserve managers will just have to keep paying up for their AUD.

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