Thought I would post this which some may find interesting.
Chris Caton is the Chief Economist for BT FInancial Group (WestPac investment arm)
"The Strong Australian Dollar. Will it Ever Fall?
In early-August, the Reserve Bank noted that the strong currency was probably having more effect on some areas of the economy than it thought likely earlier. Why is it so strong?
We keep coming up with reasons for the strong dollar, and the reasons keep faltering while the currency does not. We were told the currency was held up by strong commodity prices; they fell away but the currency did not. Then it was the fact that interest rates were so much higher in Australia than elsewhere, thus attracting capital. We cut rates and thus narrowed this differential but the currency remained robust. The explanation du jour is continued foreign buying of Australian assets, particularly long-term Government bonds. With a long-term rate of 3.25%, Australian government bonds are the highest-returning AAA-rated securities in the world, so it’s no surprise they are attractive to foreigners. The share of Commonwealth government securities held by offshore interests has doubled in the past 10 years, and now stands close to 80%.
Sooner or later, this share will stop going up, and then a source of support for the $A will be removed. Everything points to a lower dollar eventually but, to be honest, I have had that view for more than two years and it is yet to pan out.
The question has been raised as to whether the Reserve Bank is likely to intervene to drive the currency down. It has intervened in the past on a few occasions, always to hold the currency up. That is, it has sold foreign currencies and bought the Australian dollar. Such intervention has usually been profitable, with the Reserve Bank subsequently replenishing its holding of foreign exchange at a lower price. Selling the Australian dollar to drive it down may work, but it’s not a one-way bet.
Right now, the Swiss monetary authorities are intervening to hold the Swiss franc down, with some success. Why can’t we follow their example?
There are some very good reasons not to do so. First, the Swiss can’t cut interest rates to weaken the currency since their cash rate is already zero. We can. Second, Switzerland is currently experiencing deflation, so a bit of inflation as a result of a lower-than-otherwise franc would actually be desirable. And third, the Swiss national bank has massively expanded its balance sheet to accommodate its purchases of foreign exchange (including, ironically, the $A), to an extent that we simply wouldn’t (and shouldn’t) contemplate in Australia. As Governor Stevens said in his semi-annual testimony to the House of Representatives Standing Committee on Economics, Switzerland’s foreign exchange reserves total about 70% of one year’s GDP. This figure is less than 4% in Australia. Undertaking intervention on anything approaching the scale used in Switzerland would expose the Australian taxpayer to massive risk.
If the Reserve Bank really does want a significantly lower dollar, then the first thing for it to do would be simply to cut interest rates further. The fact that it hasn’t done so in the past two months suggests that, while some sectors are clearly being hurt by the currency, the Bank judges the current level of rates to be “correct” for the state of the economy as a whole. This may, of course, change in the future".
Disclaimer and Disclosure
This publication has been prepared and issued by BT Financial Group Limited ACN 002916458. While the information contained in this document has been prepared with all reasonable care no responsibility or liability is accepted for any errors or omissions or misstatement however caused. All forecasts and estimates are based on certain assumptions which may change. If those assumptions change, our forecasts and estimates may also change.