Rising global interest rates impact on the Aussie dollar
The US dollar has strengthened in recent months, forcing the Australian dollar down. The ties for the floating Australian dollar have always been close, so the growing differential between Australia’s historic low interest rates and rising US rates is of great significance.
Since August 2015 – the better part of three years – Australia’s interest rate has been at the historic low of 1.50%. Providing continued stimulus to the domestic economy has been the main driver for this super low rate, but the other reason is that global rates had headed even lower. When the RBA set its current rate, the US interest rate was 0.25% and rose to just 0.5% in December of 2015. So at that time we might argue that the premium for investing in Australia was an additional 1.0%, over the US.
But since then, albeit slowly, as the US economy has recovered, so too have its interest rates risen. In 2016, they rose to 0.75%, and to 1.5% - equal to Australia – by the end of 2017.
In March 2018, rates rose to 1.75% in the US and most recently, to 2.0%. Australia’s rate remains at 1.50%.
Where now the premium for investing in Australia?
The short answer is there isn’t one, and the implication can be read in the declining value of the Australian dollar.
The chart below, deliberately short-term and decidedly clunky, serves the purpose of emphasizing the decline in the value of the Australian dollar since the start of 2018.
Against the US dollar, the Australian dollar has fallen 6.3% (to the end of May), since the start of the year. It is a similar decline against the Yen, but movement against the Euro has been a more subdued decline of 0.4%.
To go straight to the dashboard and take a closer look at the data, click here.
Lower interest rates in Australia, especially relative the US, are contributing to the lower exchange rate. It is essentially becoming more attractive to invest in the US as each round of rate rises is signaled, leave alone implemented.
This is important because the US Federal Reserve advises expectations of yet higher interest rates over 2018.
This is not pleasing everyone, and some in Australia are profoundly bothered by the lack of action and response from the Reserve Bank of Australia.
The sometimes controversial economist Warwick McKibbin has called for a change in policy from the RBA that would see the central bank exit its inflation target (between 2 and 3% per annum) and focus more on a ‘nominal income target’, aimed at ensuring availability of resources to support economic resilience.
McKibbin has a decade on the RBA Board (through to 2011) and is a leading monetary policy theorist, in his Professorial role at ANU. Still, that does not mean he is swimming with the majority on this matter. Indeed, the majority of commentariat economists favour interest rates being held at their current historic low, into at least early 2019.
The problem with that, as McKibbin sees it, is that is delaying the inevitable. If global rates are rising, eventually the Australian interest rate must also rise. The longer that takes, the less prepared will the Australian economy be.
The next Australian currency move feels a distance away, but it’s another question whether it should be that long.