Pound Holds Ground vs. Australian Dollar as Harper Warns of Interest Rate Cut

The Australian Dollar extended its recent decline in London Friday after RBA board member Ian Harper reportedly said he cannot rule out a rate cut if the economy takes a turn for the worst.

The Pound-to-Australian Dollar exchange rate is under pressure, but it could be a lot lower were it not for the Australian Dollar's under-performance heading into the weekend.

At the time of writing, the exchange rate is quoted at 1.68 after Reserve Bank of Australia board member Ian Harper reportedly said he cannot rule out a rate cut if the economy takes a turn for the worst.

Harper was quoted by the Wall Street Journal saying; "the thing that is causing an issue for us (the RBA board) is slow growth in wages, which is feeding into slow growth in household income...If you start to lose that momentum, that might be the basis of some sort of policy action".

Currencies tend to rise as their respective central banks enter an interest rate raising cycle and fall if the opposite occurs, these comments therefore add a new dynamic to the Australian Dollar debate.

When asked, the RBA board member did not rule out the RBA slashing rates to a new record low. RBA policymakers have now left the Australian cash rate unchanged at a record low of 1.50% for 14 months in a row. 

While the point that further cuts cannot be ruled out may seem like an obvious one, Harper’s comment comes closely on the heels of a series of economic numbers that have shown households and consumers paring back spending in the face of rising debt levels and meagre wage growth.

Things took a turn for the worse Wednesday when the Australian Bureau of Statistics unveiled the worst set of retail sales numbers since March 2013, covering the month of August, and revised downward its earlier estimate of July consumer spending.

The two back-to-back sets of retail trade figures made for the largest two month decline in consumer spending since October 2010.

“Today’s data reinforces the RBA’s concern that slow wage growth and rising household debt levels would restrain household spending. These factors will likely continue to limit consumer spending for some time,” wrote Janu Chan, a senior economist at St George Bank in Sydney, in a note after the retail trade data were released.

Wednesday's retail sales figures came after the October monetary policy statement, released Tuesday, which showed policy makers praising progress across some pockets of the economy but remaining cautious on the subject of rates.

RBA governor Philip Lowe has warned on several occasions now that the bank will need to take record household debt levels into account when it eventually hikes, as a sharp increase in borrowing costs could undermine Australia’s tepid recovery from the commodity price collapse of recent years.

At its latest policy meeting the RBA kept its view that "growth in the Australian economy will gradually pick up", with non-mining investment in particular more promising.

But "slow growth in real wages and high levels of household debt are likely to constrain growth in household spending" – a warning validated by the dismal 0.6% fall in August retail sales.

"An RBA rate hike is now not fully priced until Nov 2018,” says Sean Callow, a strategist at Westpac Bank.

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Interest Rate Outlook Dims a Touch

The Australian Dollar enjoyed a good run over the second and third quarters as the economy appeared to pick up and move on from a first-quarter slowdown.

Against a backdrop of recovering commodity prices, it appeared as if the worst of the economic fallout stemming from the commodity price collapse was firmly in the past.

Strategist had begun betting on when the first rate hike might come from the RBA, with some suggesting the central bank could move in early 2018 and others forecasting it to hold off on raising the cash rate until 2019.

“We see the RBA tightening by 50bp in 2018. This would reverse the rate cuts of 2016 and take the real cash back to zero,” wrote David Plank, head of Australian economics at ANZ in a recent note. “After these hikes we see the Bank sitting pat in 2019 as highly indebted households digest the impact of higher rates.”

If anything, the recent fall in retail sales combined with other signs of a fragile consumer may mean the RBA struggles to justify a rate hike much before the 2019 end of the above forecast period.

“We expect consumer spending growth to be stuck at a lacklustre 2.5% annual pace, associated with persistent weakness in wages growth,” says Westpac economist Andrew Hanlan.

However, given the extent to which a strong currency has also been seen as an impediment to action from the RBA, it cannot be ruled out that dovish comments made Friday are simply an opportunistic attempt at talking the currency lower, for the benefit of the bank’s inflation target.

“Though the Australian dollar has fallen from around USD0.80 to USD0.78 since the September meeting, the commentary on the currency (“weighing on the outlook for output and employment”) was left unchanged,” says Hanlan, speaking of this week’s policy statement.

Australian core inflation has been below 2% since the beginning of 2016, while the RBA's madate is to target consumer price growth between the 2% and 3% thresholds. A perstistently stronger currency pushes down import costs for businesses and consumers, counteracting upward pressures in the consumer price basket coming from elsewhere in the economy.