Strong dollar casts cloud over outlook

The strong Australian dollar is keeping the Reserve Bank of Australia on edge as it observes tentative signs of improvement in the non-mining sectors of the economy.

The central bank appears likely to hold interest rates steady well into 2014 as it tries to assess how competing forces – the boost to activity from record low interest rates against the depressive effects of a high dollar, rapidly receding mining investment and below-average global growth – will work on the economy over the next few months.

The RBA has taken heart from evidence that a string of rate cuts that have pushed the cash rate down to 2.5 per cent are biting, and households are shedding much of their recent caution and life is coming back into the housing and equity markets.

As evidence of this, it points to increased demand from households for finance and a shift among savers away from low-risk assets.

In a clear warning for those hoping for more official interest rate cuts, RBA Governor Glenn Stevens said that the full effects of the rate cuts made this year are yet to be felt.

But nor does the RBA seem to be in a hurry to hike rates back toward more normal levels.

Its chief concern is the continued strength of the dollar, which has sat around the 95 US cents mark for the past month.

At this level, Stevens said, it “is still uncomfortably high. A lower level of the exchange rate is likely to be needed to achieve balanced growth in the economy”.

The RBA’s ability exert influence on the exchange rate is minor – mainly through the interest rate differential between Australian and US official interest rates – but at the margin it could encourage the central bank to hold rates lower for longer.

Another argument to keep interest rates down is doubts about how durable recent improvements in non-mining activity may be. As Stevens admitted, although private demand outside the mining sector was expected to pick up, “considerable uncertainty surrounds this outlook”.

Another concern is the move by the big banks to begin inching up their lending rates, irrespective of the stable cash rate.

There is probably never a particularly comfortable time to be a central banker, but the next few months could be a particularly white knuckle time.

 

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