From Bill Evans at Westpac today:
The minutes of the Reserve Bank board meeting on July 1 provided a mild surprise by not “strengthening” any of the language around the Australia dollar compared to the June minutes. The key sentence was: “The exchange rate remained high by historical standards, particularly given the declines in key commodity prices, and was offering less assistance than it otherwise might in achieving balanced growth in the economy”.
Contrast that with the Governor’s speech on July 3, “When judged against current and likely future trends in the terms of trade, and Australia’s still high costs of production relative to those elsewhere in the world, most measurements would say it is overvalued, and not by just a few cents”.
That was indeed strong language and had an impact on the AUD. It fell from USD 94.40 to USD 93.90 in immediate response to the speech.
It was announced shortly after the speech that retail sales in May had fallen by a surprising 0.5% and the April print was revised down to -0.1% from 0.2%. That produced another fall to USD 0.9340.
However, subsequently the AUD rallied back to USD 0.9400 – arguably retracing all of the 50c loss generated by the Governor’s strong words.
That result is in strong contrast to the Bank’s success in “talking down” the AUD late last year. Recall that following the Board meeting of November 5 the Governor described the AUD as “uncomfortably” high. At that time the AUD stood at USD 0.95. That strong language supplemented the soft easing bias which had been in place since the rate cut in August.
Each set of minutes from August noted that “Members (of the Board) agreed that the Bank should again neither close off the possibility of reducing rates further nor signal an imminent intention to reduce them”.
On it’s own the “soft” easing bias did not help in holding down the AUD. When it was first introduced at the August Board meeting the AUD was around USD 0.89. By the time of the November 5 Board meeting the AUD had lifted to USD 0.95.
It seems that the combination of the easing bias AND the strong language was successful in bringing down the AUD. From the November board meeting to the February meeting (when the policy combination was abandoned) the AUD had fallen from USD 0.95 to USD 0.87.
The decision to drop the “uncomfortably high” description and the easing bias following the February Board saw the AUD “recover” back to USD 0.95 by early June.
It seems that a combination of strong language and a preparedness to back it up with policy (easing bias) has been the only effective combination to contain the AUD.
Prior to the November Board meeting, the easing bias, on its own, had limited effect. Recently the Governor has used strong language, particularly in the speech on July 3 but, without a supporting policy change there has been little impact.
(To be fair other factors have also been at play. Low volatility encouraging the “carry trade” has also supported the AUD. But of course the disappointment for the RBA since the February board must be further intensified by the 30% fall in the iron ore price since the beginning of the year.)
So with strong language not working independently of a policy shift is there any chance that the Governor could revert back to an easing bias?
There was a modest signal on that issue in the July minutes. Language around the rate outlook was “modified” from “current accommodative stance of policy was likely to be appropriate for some time yet” to “the most prudent course was likely to be a period of stability in interest rates” – arguably an implied shortening of the “on hold” period. The July minutes also excluded the sentence (used in June): “Those uncertainties were likely to take some time to resolve”.
But this subtle change is hardly an easing bias.
To gauge this possibility we can look to the reason why the easing bias and strong language was dropped at the February meeting – underlying inflation printed 0.9% in the December quarter from 0.65% in the September quarter – the sharp increase was attributed to the fall in the AUD in 2013 – the risk was that further falls in the AUD might jeopardise the inflation strategy.
Based on the Bank’s revised inflation forecasts in the February Statement on Monetary Policy we estimate that the Bank expected a print of 0.8% for underlying inflation for the March quarter. It would have been pleasantly surprised with soft 0.55%.
A very low inflation number for the June quarter which prints next week might embolden the Bank to restore its easing bias.
After all the market is now pricing in a 60% probability of a 25 bp rate cut by early 2015 and consumer spending and housing have lost momentum, largely because of the confidence drag from the Federal Budget.
We do not think that the inflation print will be low enough to accommodate that change in strategy.
We are forecasting a 0.7% increase in underlying inflation for the June quarter. That read would see annual underlying inflation at 2.8% for the year to June – firmly in the upper half of the target range and showing no encouraging downward trend.
The best way to assess the December quarter 0.9% print on the trimmed mean (preferred measure of underlying inflation) followed by the 0.5% for the March quarter is that both numbers had some “noise” and the 2 quarter pace of 1.4% is the appropriate way to assess the trend. With the September quarter 2013 printing 0.7% the clear message is that underlying inflation is running at a steady pace of 2.8% – up from 2.3% in the previous year and hardly scope for justifying an easing bias.
Conclusion
The Bank’s experience with “talking down” the AUD points to the need to combine policy with strong language. Next week’s inflation print is unlikely to accommodate that easing bias.
Further attempts by the Governor to talk down the AUD without backing it up with policy are likely to prove as unsuccessful as we have seen in the recent past.
Notwithstanding this rather bleak assessment of the success of “jawboning” policy we do expect the AUD to lose some momentum through 2014 (USD 0.90 “target” for year’s end) in lagged response to the sharp falls in commodity prices in the first half of 2014; some lift in volatility which will discourage carry trades; and around a 5% lift in the USD Index.
All fair enough but a bit of counter-factual is useful. The dollar had broken out and had its tail up at 95 cent when Captain Glenn spoke. Today it’s testing 93 cents to the downside, in part because he mooted the macroprudential threat.
It may be that that policy tool needs to be enacted to really drive down the currency but Captain Glenn is not as naked in this struggle as our Bill suggests.
