Australian Dollar is Day's Best Performer as RBA Minutes Strike Sanguine Tone on Currency Strength, Broader Risks

One economist doubts whether RBA optimism will mean a rate hike any time soon, while another questions whether policy makers are really that optimistic at all.

The Australian Dollar is the day's best-performing currency following the release of a more-optimistic-than-expected communiqué from the Reserve Bank of Australia.

The minutes to the RBA's September meeting appeared to show policymakers taking a more optimistic tone on the Australian economy and being relatively easy with recent AUD strength.

There were concerns the RBA might come off as pessimistic or attempt to talk down the currency given its strong gains in 2017.

Rate-setters flagged second-quarter gains in the labour market, a moderation of the fall in mining investment and an ongoing pickup in non-mining business investment as reasons for cheer and why domestic growth can be expected to accelerate going forward.

Of particular note for currency markets, the RBA acknowledged that much of the year-to-date strength seen in the Australian Dollar is due to a broad weakening of the US Dollar as opposed to any unwarranted appreciation. 

Nevertheless, the currency's strength could become a concern going forward.

“The appreciation of the Australian Dollar over recent months, driven in part by a broad depreciation of the US Dollar, was weighing on domestic growth and contributing to subdued inflationary pressure. A further appreciation of the Australian Dollar would be expected to result in a slower pick-up in growth and inflation,” the minutes say.

The Pound-to-Australian-Dollar exchange rate edged lower by 0.05% during early trading, to be quoted at 1.6946, while the AUD/USD exchange rate rose 0.22% to 0.7987.

The Australian Dollar has gained more than 10% on the Greenback during the year to date, as the economy gathered momentum, the Dollar weakened and traders turned their attention back toward the future path of Australian interest rates.

Relative to the Japanese Yen and the New Zealand Dollar, the Aussie has risen by more than 5%, while it has also knocked Sterling, the Canadian Dollar and the Swiss Franc down a peg.

This appreciation makes Australian exports more expensive on the international market place and hinders the country's ability to diversify away from mining.

"If the FOMC continues on its course of gradual rate increases and a slow reduction in balance sheet size, the RBA is likely to have scope for some modest monetary tightening in 2018 without triggering a sharp, excessive appreciation of the Australian dollar," says Derek Halpenny, European head of global markets research at MUFG.

Above: This year's performance by the Australian Dollar.

Balancing Act on Household Debt

There was also an emphasis on the need to balance high household debt levels and low wage growth with an eventual rise in inflation when it comes to future interest rate decisions.

This observation rules out the potential for interest rates to be cut further; indeed a rate rise with these issues in mind might be interpreted as higher borrowing costs tend to cap household borrowing.

At the same time, raising rates when households are endebted raises its own set of problems in terms of repayments and many therefore don't expect a pro-AUD interest rate rise being delivered anytime soon.

"Spare capacity in the labour market, concerns over the exchange rate, wages growth and household balance sheets suggest that the RBA is still far from considering a rate hike in the near term," says Janu Chan, an economist with St George Bank. "We are maintaining our long-held view that the RBA will keep the cash rate steady into 2018."

The RBA noted financial markets are pricing in an initial rate hike around the mid-point of 2018.

"Taking into account all of the available information, and the need to balance the risks associated with high household debt in a low-inflation environment, the Board judged that holding the stance of monetary policy unchanged would be consistent with sustainable growth in the economy and achieving the inflation target over time,” the minutes say.

Not Quite As Optimistic?

But some economists are not quite as optimistic about the RBA’s thinking on the economy as Governor Lowe seemed to indicate it was just a few short weeks ago, or as foreign exchange markets have been of late.

“The minutes are not quite as upbeat as the Governor’s statement indicated,” says Bill Evans, chief economist at Westpac. "The improved labour market conditions are recognised but clearly qualified by an expected slow response from wages and ongoing spare capacity."

Evans sees consumer spending and the jobs market dominating the RBA debate during 2018, given ongoing weakness of wage growth, while the bank’s tinkering with loan-to-value ratios in the mortgage market is likely to keep the housing market in check.

“The sustained application of macro-prudential policies is likely to continue to ease conditions in housing markets precluding any need for the Bank to raise rates next year,” Evans writes in a briefing to clients.

House Prices Trending Down

A core concern of Australian rate setters has been runaway price growth in the housing market after years of construction that was insufficient enough to keep up with population growth.

But Tuesday’s reading of the house price index, by the Australian Bureau of Statistics, showed the deceleration of price growth that began in the final quarter of 2016, continuing during the three months to the end of June.

House prices rose at a rate of 1.9% between the end of the first quarter and the end of the second quarter, according to the data, marking a fall from the 2.2% growth seen in the previous period.

Prices still rose at a double digit rate of 10.2% on an annual basis although the pace of growth now appears to be slowing.

Slowing house price rises will take the pressure of the RBA to raise interest rates in the near-term and the RBA will be hoping that price increases will continue to cool.

The overall message - the RBA is likely to be struck by a state of inertia for some time.

In this environment we would expect the Aussie to find upside traction, particularly if global commodity prices and broader market sentiment stays bouyant.

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