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How will the RBA react to inflation? How will the RBA react to inflation?
(2 months later)
The inflation figures out on Wednesday could signal an end to Australia’s low inflation, coming mostly on the back of our high exchange rate.The inflation figures out on Wednesday could signal an end to Australia’s low inflation, coming mostly on the back of our high exchange rate.
For the past three years the Australian dollar has been stronger than at any time since the currency's float in December, 1983. This, like everything in economics, is good and bad. Good for people who like buying things from overseas, bad for people whose businesses rely on selling things to people overseas (which includes tourists coming to Australia).For the past three years the Australian dollar has been stronger than at any time since the currency's float in December, 1983. This, like everything in economics, is good and bad. Good for people who like buying things from overseas, bad for people whose businesses rely on selling things to people overseas (which includes tourists coming to Australia).
How high has the dollar been? Well, since the float, the average value of the Australian dollar has been US$0.75. In the past three years the average has been US$0.97, about 30% above the long-term average. Even if we lengthen the scope to the past five years, we’re still looking at an average of US$0.93, and that includes the one-year period during the GFC when the dollar plunged to US65c:How high has the dollar been? Well, since the float, the average value of the Australian dollar has been US$0.75. In the past three years the average has been US$0.97, about 30% above the long-term average. Even if we lengthen the scope to the past five years, we’re still looking at an average of US$0.93, and that includes the one-year period during the GFC when the dollar plunged to US65c:
In the past three months the value of the Australian dollar has declined 11% against the US dollar to about 90c. But it remains historically overvalued.In the past three months the value of the Australian dollar has declined 11% against the US dollar to about 90c. But it remains historically overvalued.
The Bank of International Settlements (BIS) has changed its value of the dollar’s “effective exchange rate” (the value of our exchange rate against a basket of 26 other currencies) from a high of 114.7 in April to 105.2 in June. However, it remains valued above the average of the 27 currencies the BIS uses to formulate its effective rates. To give some context, at no stage from February 1985 to April 2010 did that occur. Even with the 11% fall in our currency, the BIS still rates it as the currency with the 7th highest effective exchange rate.The Bank of International Settlements (BIS) has changed its value of the dollar’s “effective exchange rate” (the value of our exchange rate against a basket of 26 other currencies) from a high of 114.7 in April to 105.2 in June. However, it remains valued above the average of the 27 currencies the BIS uses to formulate its effective rates. To give some context, at no stage from February 1985 to April 2010 did that occur. Even with the 11% fall in our currency, the BIS still rates it as the currency with the 7th highest effective exchange rate.
And bear in mind that for most of 1990-2010 the BIS rated Australia with either the lowest effective exchange rate of the 27 currencies or near to it:And bear in mind that for most of 1990-2010 the BIS rated Australia with either the lowest effective exchange rate of the 27 currencies or near to it:
So we’re still some way from having an undervalued currency. The conditions for exporters are better than they were three months ago, but they remain worse than they have been for much of the past 30 years.So we’re still some way from having an undervalued currency. The conditions for exporters are better than they were three months ago, but they remain worse than they have been for much of the past 30 years.
But the exchange rate isn’t just about exports; because it affects the price of imports, its impact on the inflation rate is crucial, and the next inflation figures, out on Wednesday, cover the period where the value of our dollar dropped so quickly.But the exchange rate isn’t just about exports; because it affects the price of imports, its impact on the inflation rate is crucial, and the next inflation figures, out on Wednesday, cover the period where the value of our dollar dropped so quickly.
The Consumer Price Index is essentially made up of two groups: tradeable and non-tradeable commodities. Tradeable commodities are things for which prices are largely determined on the world market – things such as petrol, but also computer equipment, clothing and anything else you are buying that has come from overseas. Non-tradeable commodities are things that are not bought or sold overseas – things such as your electricity bill, takeaway food, bread, milk, medical insurance, rent, housing prices and sewerage. They are the prices which the Reserve Bank of Australia (RBA) worries about the most.The Consumer Price Index is essentially made up of two groups: tradeable and non-tradeable commodities. Tradeable commodities are things for which prices are largely determined on the world market – things such as petrol, but also computer equipment, clothing and anything else you are buying that has come from overseas. Non-tradeable commodities are things that are not bought or sold overseas – things such as your electricity bill, takeaway food, bread, milk, medical insurance, rent, housing prices and sewerage. They are the prices which the Reserve Bank of Australia (RBA) worries about the most.
The non-tradeable things account for about 60% of the CPI, but in the past two years, while local-priced items have stayed relatively flat, the overall inflation rate has benefitted from a fall in the price of tradeable items.The non-tradeable things account for about 60% of the CPI, but in the past two years, while local-priced items have stayed relatively flat, the overall inflation rate has benefitted from a fall in the price of tradeable items.
But if the exchange rate goes down, the price of tradeable goods should rise (and vice versa). For example, if the exchange rate is at US$1.05 then to buy an imported Blu-Ray player that costs $US200 means only having to pay $190.47 in Australian dollars (ignoring shipping, mark-ups etc). If the value of the dollar falls to US$0.90, then that Blu-Ray player would cost $222.22 in Australian dollars.But if the exchange rate goes down, the price of tradeable goods should rise (and vice versa). For example, if the exchange rate is at US$1.05 then to buy an imported Blu-Ray player that costs $US200 means only having to pay $190.47 in Australian dollars (ignoring shipping, mark-ups etc). If the value of the dollar falls to US$0.90, then that Blu-Ray player would cost $222.22 in Australian dollars.
That’s the theory anyway.That’s the theory anyway.
It doesn’t always happen like that because it depends on what is happening overseas, what suppliers are charging Australian businesses and the level of competition here in Australia. Sometimes a business can pocket the profit from the improved exchange rate and not “pass on the savings” to the consumer. For example, from 2010 to 2012, while our exchange rate went up, oddly, so too did the price of tradeables. But the high dollar eventually led to a point where, in the past 18 months, the price of imports has actually been falling.It doesn’t always happen like that because it depends on what is happening overseas, what suppliers are charging Australian businesses and the level of competition here in Australia. Sometimes a business can pocket the profit from the improved exchange rate and not “pass on the savings” to the consumer. For example, from 2010 to 2012, while our exchange rate went up, oddly, so too did the price of tradeables. But the high dollar eventually led to a point where, in the past 18 months, the price of imports has actually been falling.
This time, however, it seems the decline in the dollar is causing an instant rise in the price of tradeables. As the stockbroking firm Commsec has noted, the decline of the dollar alone has caused petrol prices to rise about 15c per litre. That will cause a hit on the overall CPI.This time, however, it seems the decline in the dollar is causing an instant rise in the price of tradeables. As the stockbroking firm Commsec has noted, the decline of the dollar alone has caused petrol prices to rise about 15c per litre. That will cause a hit on the overall CPI.
But the question is how the RBA will react to the CPI figures out on Wednesday. The market is pricing in a 65% chance of the RBA next month cutting the cash rate from 2.75% to 2.50%. Given a lower cash rate (or at least the expectation of a lower cash rate) will assist in lowering the value of the dollar, it would be odd for the RBA to react against an increase in tradeables given it has assisted in that occurring.But the question is how the RBA will react to the CPI figures out on Wednesday. The market is pricing in a 65% chance of the RBA next month cutting the cash rate from 2.75% to 2.50%. Given a lower cash rate (or at least the expectation of a lower cash rate) will assist in lowering the value of the dollar, it would be odd for the RBA to react against an increase in tradeables given it has assisted in that occurring.
But the inflation of those non-tradeable products is now just over 4%. When it rose that fast in 2007-08 the RBA started raising rates. Of course, back then our currency had one of the lowest effective exchange rates in the world, so the RBA didn’t have to worry about keeping the dollar low. At the moment it has a policy which, in effect, causes inflation. The question is whether it is the type of inflation the RBA is comfortable with to enable it to once again cut interest rates.But the inflation of those non-tradeable products is now just over 4%. When it rose that fast in 2007-08 the RBA started raising rates. Of course, back then our currency had one of the lowest effective exchange rates in the world, so the RBA didn’t have to worry about keeping the dollar low. At the moment it has a policy which, in effect, causes inflation. The question is whether it is the type of inflation the RBA is comfortable with to enable it to once again cut interest rates.
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