Glenn Stevens the RBA Governor gave a wide ranging interview to the Australian Financial Review which was published this morning. In it he talked about monetary policy, structural change in the economy and of interest to us here at Global FX the Australian dollar.
There has been some comment that his thoughts on monetary policy have hurt the Aussie Dollar but for mine we heard from an RBA Governor who is not at all phased by the strength of the Aussie nor the structural changes it is causing within the economy. I also see the theme that seems to permeate RBA thinking in that the changes in the economy and the changes in the relative price of Australian exports is a structural and permanent change.
Thus he is very relaxed with the Aussie where it is.
The highlights were:
- The Aussie dollar is behaving very differently to what has been the historical experience or what the RBA thought would happen – “given that the terms of trade are down 15 per cent now”
- Consequently the AUD is “a bit high for the circumstances”
- The high Aussie dollar is distorting monetary policy.
- Stevens seems to think that we have seen a persistent if not permanent shift in relative prices which will underpin the Aussie dollar well above the previous long run average. He doesn’t know what the new average will be but it is likely to be higher
- Stevens doesn’t rule out intervention – “we don’t rule out intervention as a matter of principle. It can be useful on occasions”.
- But the RBA is not about to cap the Aussie Dollar in the manner that the Swiss National Bank did. Mainly because the settings in Australia are different but also because it would cost us too much – “we would be taking a negative carry on that position, because we would essentially be selling the foreigners assets earning 3 per cent, and holding their assets earning nothing. The Swiss aren’t in that position because their rates, their interest rates are zero.”
- The structural change in the economy being wrought by the high Aussie is just what happens when relative prices change.
The full interview is here and I have the Aussie Dollar relevant piece below but my take away is that yes the Aussie dollar is uncomfortably high but it is not unreasonably high as it was in the case of the Swiss Franc. It is likely to persist at these relatively high historical levels for an indefinite period.Monetary policy will be calibrated to take into account the high Aussie Dollar and the structural change that is occurring but the RBA does not seem overly uncomfortable with the level at the moment.
It is clear in the chart above that in the box that the Aussie is persistently holding above what used to be the top of the range in which it trades. This mid 95 reegion looks like it is going to be longer term support and in time as the relative price shift persists, if it does, then the risk has to be for a topside probe at some point.
Stevens’ Comments on the Aussie Below:
AFR: How big a problem is the Australian dollar in all of this, including in this difficulty of forecasting the future of output and inflation?
Stevens: The currency is today a little stronger than we had been assuming if you went back a year – there’s not a huge amount in that but it is stronger.
I think one of the potential forecast difficulties is that previous experiences with the exchange rate – we certainly had quite big cycles around what was clearly a lower mean level than we have today. We didn’t have an extended period of a much higher level.
So, it’s possible that it turns out to be quite difficult to forecast the full effects of a very persistent shift up, because the modelling experience and so on of the past 30 years doesn’t have such an episode in it.
That’s possible, I think more generally though the exchange rate being persistently quite high, and I mean we can come back to whether it’s too high or not, but I don’t think it’s any surprise that it’s persistently much higher given what’s happened to the terms of trade in the global economy.
We’ve had a very big shift in relative prices, unless you think all of that is temporary, we can’t know, but if that turns out to be persistent and it certainly has been pretty persistent so far, that means a couple of things.
One is – you would expect the exchange rate to be persistently high but you’d also expect that the structure of the economy is going to change. Some sectors will grow, some will shrink, that’s what happens when relative prices alter.
It’s not pleasant, the people who are on the downside of the relative price shift don’t like it obviously – who would? But that is what the global economy has handed us by the look of it. And so structural adjustment will occur, you can’t really stop it. Exchange rates are part of that but it is reflective of this deeper thing that I think has happened in the global economy.
AFR: You just raised the point as to whether the exchange rate was too high. Phil Lowe last week characterised it as being uncomfortably high. Would the bank rather that the dollar responded as it usually does in relation to the terms of trade to play its stabilising force?
Stevens: What we’ve said so far is more or less that it’s a bit surprising that it hasn’t come down more than it has to date – given that the terms of trade are down 15 per cent now.
It’s still the case that most of the former models we have for the exchange rate, for what they’re worth, it looks a bit high compared to those.
Although, if you were doing a formal statistical test I’m not sure that you have a lot to write home about. I think, as I say, that there are reasons to think that it might be consistently higher than we used to experience and that a number of sectors are going to have to adjust to that but that said, as I’ve said before, it does seem to be a bit on the high side at the moment.
AFR: Persistently higher and remaining persistently higher?
Stevens: Probably a higher mean. I guess what I’m saying is we used to think of the mean exchange rate as you know 72 or something US, 56 or 57 TWI.
No-one can say what the new mean or the new normal might be, but if you think that relative prices have shifted persistently, terms of trade aren’t going to go all the way back. If that’s what you think then you would expect a higher mean exchange rate from here. Not necessarily this high though.
AFR: Alright but does this not mean something difficult or dangerous in monetary policy? Correct me if I’m wrong, but interest rates wouldn’t be at 3 per cent now if it weren’t for the dollar. You’ve got to make up for the dollar, but in the process you’re stoking up a whole lot of interest rate sensitive demand including asset prices and so forth. Don’t you end up in a bit of a wedge there?
Stevens: It’s the thing we have to be wary of – I mean the classic problem in a situation like this can be that you seek to compensate for a very high exchange rate with cheaper, lower interest rates.
That can – in some circumstances – give you the asset credit build-up that then gets you into trouble later.
So we’re mindful of that, I don’t really think we’re seeing that though at the present time.
We’ve seen some pick-up in housing prices, as you’d expect with interest rates coming down, but I don’t think we’re seeing at the moment a dangerous leveraging up there by households.
Household credit growth is actually still pretty moderate and I think there’s plenty of people still seeking to get their leverage down.
So, that’s a potential danger but I don’t think it is one which is being crystallised, at least not that we see at present.
AFR: With the cash rate down to 3 per cent, this is good for rate-sensitive mortgage borrowers but perhaps bad for savers. And with the ageing of the population, does both that exchange rate effect and going so low on interest rates mean that monetary policy may have a more muted effect than it had before?
Stevens: Well, I think it’s always worked partly on the saving margin, it’s always partly been the case that policy works when we’re moving down, not just by helping the borrowers but by changing the incentives that the savers face.
That’s always been true, and certainly the tone of the correspondence that I’m getting now is that savers are starting to notice that the incentives are shifting.
Having said that, you can still get pretty or very low risk saving instruments like bank accounts at an interest rate that is above the inflation rate.
So it’s coming down for them and that’s part of how policy works. I don’t think it’s in any sense gone into uncharted territory though, and I don’t really think at this point there’s any particularly clear evidence that policy is failing to work. It’s too soon really to have seen all the effects of the things we’ve done.
AFR: Well the exchange rate is throwing sand in the wheels.
Stevens: Possibly, if it behaves very differently to past experience but that, at the moment, I think that all I’m prepared to say on the exchange rate is that it seems a bit high for the circumstances, we should be asking why that’s happening because there could be something that we haven’t yet thought of that could be at work. And we do ask those questions but it seems to me a bit high. If it completely changes its behaviour with respect to history then obviously that’s an issue but it isn’t clear that you can quite say that right at the moment I don’t think.
AFR: What would you say to manufacturers who are obviously doing it tough? And why can’t you just do what the central bank of Switzerland has just done – put a cap on the dollar at what you regard as the right rate?
Stevens: Well let’s talk about what the Swiss did. Firstly, they had a very high exchange rate by historical circumstances. Under pronounced upper pressure they did quite a lot of intervention of the conventional kind and they weren’t able to hold it.
The macroeconomic backdrop that they had was price deflation, which we don’t have, and then it shot up from there and it’s reached an exceptionally high level, and that’s the level where they’ve said ‘we’re now going to cap it’, and that seems to be working for them.
There’s been a very large build-up of foreign currency reserves – you know 70 per cent of Switzerland’s annual GDP worth – if we had to do that, that is a lot of money. In our case we would be taking a negative carry on that position, because we would essentially be selling the foreigners assets earning 3 per cent, and holding their assets earning nothing. The Swiss aren’t in that position because their rates, their interest rates are zero.
This is the other thing – they have no other device left for easing policy in an environment of price deflation, well we’re not in that environment at all. So I think there are a number of differences between the Swiss situation and ours that are quite fundamental to why we’re not at this point doing what they’re doing, and I’d very much hope we don’t get to that point.
AFR: The view of the banks so far is refraining from any significant intervention. Would that be the next step if things got more uncomfortable?
Stevens: Well we haven’t made serious overt attempts to push down the currency in this recent episode.
We don’t though, we don’t rule out intervention as a matter of principle. It can be useful on occasions. Were it to be appropriate and useful, we’d certainly consider it, but we haven’t done so yet, and we’re unlikely to signal ahead of time, really an intent; but we certainly don’t rule it out under exceptional circumstances.
AFR: You talk about accepting the dollar will behave differently to history. But can manufacturers and others in the trade-exposed industries expect the dollar to go back to anything like its post-float average in the mid 70s, say in the next 10 years?
Stevens: Well no one knows, you know history is replete with seriously bad forecasts of exchange rates as you know, so anyone who tells you they know the answer to that; I think a good deal of scepticism should be applied.
What we know about behaviour of exchange rates, or of this exchange rate anyway, suggests that it hinges a lot on your view of whether this relative price shift that we’ve talked about, is it permanent or temporary? Well actually, it hasn’t been temporary; it’s long enough that it’s affecting a 10-year average of the terms of trade.
So it’ been pretty persistent. All these other booms in the past have ultimately ended with things going way back down, so you can’t rule it out here. And in that world I think it would be very surprising if the exchange rate didn’t go down, quite materially. But if this relative price shift turns out to have a good deal of persistence, even if not at current levels, then I think one could expect the exchange rate is around a higher long-run average as a result of that.
I don’t know what that average is, but it would be unlikely that it would be in the low numbers that we have become accustomed to until the last five or six years ago.