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Foreign Exchange

Is it time to start worrying about intervention in the AUD?

The Reserve Bank of Australia, which meets on Tuesday, is starting to show concerns over the value of its currency not seen since the financial crisis.

In the last quarter of 2008, the RBA intervened to support the Aussie dollar as the massive wave of deleveraging, sparked by the collapse of Lehman Brothers, saw investors pile out of carry trades. One Friday morning that October, when AUDJPY tumbled 10 big figures – that was its biggest one-day fall since the RBA devalued the currency by 17.5% in 1976.

The RBA has a very different issue with its currency now.

With the bank’s own trade-weighted Australian dollar index hitting a multi-month high and the country’s terms of trade declining, the central bank is puzzled over the strength of its currency.

Last week, Glenn Stevens, RBA governor, told lawmakers in Sydney he was not attracted to the idea of intervening to weaken the Australian dollar, but the bank did retain it as an option.

That caveat would seem important, since he added that he and his colleagues at the RBA continued “to ask ourselves whether what is happening in the currency markets makes sense”.

“The most recent bout of strength is coming at a time when the terms of trade have actually peaked and started to come down,” he added. “That’s a bit odd.”

 AUD trade-weighted index versus terms of trade

 
 Source: Reuters Ecowin, Bloomberg, BNP Paribas

Meanwhile, incoming RBA board member Heather Ridout raised fears over the potential for Dutch disease in the Australian economy, echoing increasing worries that the effect of the success of the mining sector on the Aussie could destroy other sectors of the economy.

Ridout said there was “too much froth in the Australian currency”, and that “speculative” buying stoked by interest rate differentials had boosted the Aussie dollar.

She added that monetary policy had been given an awful lot of support in Australia by the high value of the currency and that needed to be factored in to the central bank’s decision making.

“I will be making those points pretty strongly when I sit at the table,” she said. Ridout takes her place at that table on Tuesday.

However, the likelihood that the high value of the currency will spark the RBA into action seems slim.

First, while Stevens’ comments on the terms of trade do stand up, the fall has been relatively small.

Not only that, it is slightly disingenuous to suggest the rise in the Aussie does not make sense.

There are other factors at work, not least that the country’s AAA rating has increased its attractiveness as a reserve currency.

This can be seen in the increasing foreign ownership of the country’s government bond market. Indeed, assistant RBA governor Guy Debelle pointed out just last month that a record 75% of Australian government debt was now foreign-owned.

Furthermore, Ridout’s concerns over Dutch disease do not appear to be stacking up – yet at least.

Raymond Attrill, strategist at BNP Paribas, says there is little evidence that the terms-of-trade shock caused by the strength of the mining sector and its affect on the currency is spilling over into the rest of the tradable goods sector.

Attrill, who believes AUDUSD is capable of breaking through July’s record high of $1.1070 to hit $1.15 later this year, notes that neither the Australian manufacturing nor tourism sectors are suffering due to currency strength. Indeed, only the country’s education exports appear affected, with many international university students attracted to the US at Australia’s expense.

“The RBA also continues to stress it expects the ongoing investment boom in the resources sector to last for many years to come,” notes Attrill.

“If it did not, it would be much more reasonable to expect that it would be inclined to take action to limit hollowing out of the tradable good sector from exchange-rate strength driven by what was seen as a temporary shock.”

Of course, another factor that should stop the RBA from any action is the argument that Australian households have benefited from currency strength. In its last forecasts, when AUDUSD stood at $1.07, the central bank has inflation rising towards the upper end of its target.

Thus, if AUDUSD were lower, interest rates would have to rise.

While the strength of its currency might be puzzling the RBA’s governor and concerning its newest member, intervention seems a long way off.

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