The Reserve Bank of Australia (RBA) Chief Economist, Sarah Hunter, made a surprising revelation on Wednesday, stating that the Australian economy is currently running hotter than previously anticipated.
Key Quotes
Economy running bit hotter than RBA thought previously.
Will focus on trimmed mean CPI.
Market Reaction
At the time of writing, AUD/USD is trading 0.02% lower on the day at 0.6520.
RBA FAQs
The Reserve Bank of Australia (RBA) sets interest rates and manages monetary policy for Australia. Decisions are made by a board of governors at 11 meetings a year and ad hoc emergency meetings as required. The RBA’s primary mandate is to maintain price stability, which means an inflation rate of 2-3%, but also “..to contribute to the stability of the currency, full employment, and the economic prosperity and welfare of the Australian people.” Its main tool for achieving this is by raising or lowering interest rates. Relatively high interest rates will strengthen the Australian Dollar (AUD) and vice versa. Other RBA tools include quantitative easing and tightening.
While inflation had always traditionally been thought of as a negative factor for currencies since it lowers the value of money in general, the opposite has actually been the case in modern times with the relaxation of cross-border capital controls. Moderately higher inflation now tends to lead central banks to put up their interest rates, which in turn has the effect of attracting more capital inflows from global investors seeking a lucrative place to keep their money. This increases demand for the local currency, which in the case of Australia is the Aussie Dollar.
Macroeconomic data gauges the health of an economy and can have an impact on the value of its currency. Investors prefer to invest their capital in economies that are safe and growing rather than precarious and shrinking. Greater capital inflows increase the aggregate demand and value of the domestic currency. Classic indicators, such as GDP, Manufacturing and Services PMIs, employment, and consumer sentiment surveys can influence AUD. A strong economy may encourage the Reserve Bank of Australia to put up interest rates, also supporting AUD.
Quantitative Easing (QE) is a tool used in extreme situations when lowering interest rates is not enough to restore the flow of credit in the economy. QE is the process by which the Reserve Bank of Australia (RBA) prints Australian Dollars (AUD) for the purpose of buying assets – usually government or corporate bonds – from financial institutions, thereby providing them with much-needed liquidity. QE usually results in a weaker AUD.
Quantitative tightening (QT) is the reverse of QE. It is undertaken after QE when an economic recovery is underway and inflation starts rising. Whilst in QE the Reserve Bank of Australia (RBA) purchases government and corporate bonds from financial institutions to provide them with liquidity, in QT the RBA stops buying more assets, and stops reinvesting the principal maturing on the bonds it already holds. It would be positive (or bullish) for the Australian Dollar.
Analysis
The revelation by RBA Chief Economist Sarah Hunter that the Australian economy is running hotter than expected could have significant implications for the Australian Dollar (AUD) and monetary policy. If the economy continues to outperform expectations, the RBA may be forced to raise interest rates in order to maintain price stability. This could lead to a stronger AUD and increased capital inflows from global investors. On the other hand, if inflation continues to rise, the RBA may consider implementing quantitative tightening to curb inflationary pressures, which could have a bullish effect on the AUD. Overall, investors should closely monitor economic indicators and RBA statements to gauge the future direction of the Australian economy and its impact on the currency markets.