Wednesday, August 08, 2012

Our unreasonably high dollar concerns the RBA. It is opening its mouth

The Reserve Bank has turned to ‘open mouth’ operations in a bid to hold back the rising Aussie dollar.

The Bank inserted a sentence of exchange rate commentary into the statement released after yesterday’s board meeting in a conscious attempt to let the market know it thought the dollar was higher than could be justified by the usual metrics.

The sentence said the exchange rate had “remained high despite the observed decline in the terms of trade and the weaker global outlook”.

The Aussie-US exchange rate has climbed 6 per cent during two months in which base metal prices have fallen 6 per cent.

The Bank believes the dollar is soaring despite the lower prices because foreign investors have settled on Australia as a safe place to park their money.

A big part of yesterday’s Sydney board meeting was given over to discussing the high dollar and what - if anything - to do about it.

One option - not ruled out - is intervene in the foreign exchange market by selling dollars and buying foreign currency as the Bank has done on rare occasions in the past.

This option carries a risk of being stuck with foreign assets that would turn out to be a bad investments, a criticism that can be levelled at China's policy of investing abroad in order to hold back its currency.

The Bank is taking the view for the moment that there is little evidence of broad economic damage flowing from the high dollar, meaning it can wait. Economic growth is strong, employment is climbing and inflation is low.

If needed, the Bank would restrain the dollar in other ways, by feeding concern about the high dollar into its decisions about whether to cut interest rates; in the same way as it feeds concern about bank funding costs into those decisions.

For the moment it is watching the dollar, letting people know it is watching the dollar, and keeping its options open.

In today's  Sydney Morning Herald and Age

Mckibbin: How the RBA should clip the dollar

There is a danger in economic debate to believe that the correct response to one economic shock must be the same for all shocks. This is particularly true when considering the role of the strong Australian dollar and its impact on traded goods, but particularly on manufacturing.

It is clear that it is better to take the appreciation of the real exchange rate caused by a commodities boom through a stronger currency rather than through higher inflation. However, it is important to understand that whether or not to intervene in the foreign exchange market depends on the shock hitting the economy. Allowing a pure float is not always optimal, especially if you have information on the nature of the shock driving the exchange rate.

There are many factors driving the value of the Australian dollar. The case of foreign central banks buying Australian dollars is particularly unusual. It is difficult to find a song that could explain what to do in this case, but there is a large economics literature, particularly written during the 1980s, that gives important insight on the question as to whether there is ever a case for foreign exchange market intervention...

Continued at

Koukoulas: An RBA recipe for Aussie dollar relief

The Australian dollar is overvalued. This morning, ahead of the RBA board meeting, it is hovering around $US1.0560 and on the RBA’s trade weighted index, it is around 79.4 points.

The last time the Australian dollar was at this lofty level on the TWI was back in February 1985, a bit over a year after the start of the float and a time when foreign exchange markets were still adolescent.

The current Australian dollar bubble, which it increasingly seems to be, is inflicting damage on the Australian economy. Exporters are being undermined due to a loss of competitiveness and those local industries competing with imports are under even greater stress as prices for many imported goods and services fall. The high Australian dollar will see inflation remain very low, both directly through lower import prices but also via its dampening effects on the domestic economy...

Continued at BusinessSpectator

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