Australia not the new Switzerland; RBA FX intervention impotent
Reserve data from Australia has sparked speculation that the Reserve Bank of Australia (RBA) is leaning against strength in the AUD, but the notion that it will follow Switzerland and adopt a more aggressive approach to its currency’s resilience is wide of the mark.
Figures from the RBA spawned the notion that the central bank has been “passively” intervening in the AUD.
They showed a sharp uptick in the pace of RBA reserve accumulation of A$863 million in August and September, far above the post-January 2010 average of A$54 million a month.
By choosing not to convert the foreign currency that accumulates on its balance sheet into AUD, the RBA is, in effect, reducing the upward pressure on the Aussie dollar, some say.
RBA FX transactions (A$ billion)
|Source: ANZ, RBA|
Andrew Salter, FX strategist at ANZ, says for most of the past four month, the RBA has spoken about the overvalued level of the AUD and its divergence with Australian fundamentals, such as commodity prices.
“This policy decision sends a clear signal of an evolution in the bank’s views on the currency and its inclination to act on this view,” he says.
ANZ estimates that fair value for AUDUSD stands at around $0.90 to $0.95. What has powered the Australian currency above parity has been demand from foreign central banks and sovereign wealth funds, which have been diversifying their holdings away from core global bond markets amid an environment of deteriorating credit conditions and low interest rates.
The sheer size of those inflows casts doubt on whether the RBA has decided to take on the market.
Indeed, the recent RBA reserve accumulation is tiny compared with typical foreign accumulation of AUD, a fact that means the central bank will face a Herculean effort if it has decided to engage in currency intervention.
Considering only allocated reserves – just 55% of the total – from the International Monetary Fund’s Cofer data, global reserve managers have bought nearly $250 billion of ‘other’ currencies between 2003 and the second quarter of 2012.
Citi says that represents $13 billion a quarter, of which it suspects AUD accounts for the larger share.
“Thus, even using a very restrictive set of assumptions, and leaving aside considerations on private sector flows, it is clear that RBA selling of about $1 billion per quarter would not come close to offsetting foreign official interest to buy AUD should the trends of the past several years continue,” says Todd Elmer, strategist at Citi.
“The more important factor for AUD direction is likely to remain the degree of foreign appetite.”
Elmer concedes it is possible that the apparent shift in reserve management at the RBA is part of a suite of measures, including rate cuts, intended to signal increased discomfort with the level of the AUD. It could, he says, imply a threat that further action could be taken if the divergence between the AUD and the country’s economic fundamentals continues to grow.
However, Elmer believes the effect of that signalling on the AUD will be weak.
“That is because it would be difficult for the RBA to directly control the trend in the exchange rate, even if it fully set itself to the task,” he says.
“The RBA has direct control over interest rates, but recent easing has done relatively little to derail AUD.”
Stronger verbal intervention from the RBA might be seen, but that is unlikely to be viewed as a prelude to heavy-handed Swiss-style intervention, given that a move from the central bank to target the level and direction of the AUD would not be seen as credible.
“The problem for Australia is that, unlike Switzerland, it does not face deflation and exceptionally weak growth, so it is likely that any intervention policy will be viewed as unsustainable,” says Elmer.
“This might only encourage investors to buy more AUD in anticipation of an eventual reversal of the currency policy.”
The RBA will be aware of that, and aware too that risk appetite, in particular the path of Chinese growth, is more likely to affect the direction of the AUD than its own policy decisions.