Australian dollar and the RBA: dirty deeds don’t come cheap

The Australian dollar is in the crosshairs of accelerating domestic price pressures and global central banks re-asserting their hawkish wares.

Reserve Bank of Australia (RBA) Governor Philip Lowe will be testifying before the Senate this week. Another grilling of the effectiveness of the bank’s communication methods appears likely to be at the top of the agenda.

On Wednesday, Mr Lowe will appear before the Senate estimates committee and then on Friday he will deliver his semi-annual testimony to the House of Representatives Economics committee.

Wedged in between those public appearances will be jobs data on Thursday.

The pandemic induced ultra-loose monetary and fiscal policy across the globe. With so much uncertainty at the time, that response was understandable. Aside from China, the pandemic is mostly over in the major economies.

For central banks, they have had to flick the ugly lights on, turn the music off and let everyone know that the party is over. The dirty deed of free money now has a price that needs to be paid in order to return economies toward focussing on productivity gains.

In Australia, a favourite pastime for some parts of the mainstream media is to invoke the mortgage belt to run for their torches and pitchforks whenever there is a rate hike.

Unfortunately, such popularism gains more traction than it should and only encourages these outlets to continue to undermine rationale economic management to sell more copy.

The reality is that high and unstable inflation creates uncertainty and increases the cost of capital to a more expensive level than it would otherwise be with low and stable inflation. A significant component of pricing debt is the outlook on inflation expectations.

If this component carries a high degree of risk, the return required to justify the bond investment will also be higher, adding to the debt burden.

This may create a drag on national productivity which could lead to a long-term lower standard of living than would otherwise be the case.

So, while some politicians in Canberra might be salivating at the prospect of shifting the blame of tighter financial conditions onto the RBA, it is merely the cost of the deeds of the past.

For the Aussie dollar, the RBA is in a race with other global central banks to raise rates to the point where demand is suppressed enough to take the heat out of inflation.

Last week highlighted that those bankers with the loudest hawkish voices are being heard and their currencies could continue to respond in kind, at least in the short-term, until another central banker says something.

The gumption of the RBA in the meetings ahead may drive AUD/USD. While cash rates remain in favour of the US Dollar, bond spreads at the two- and ten- year part of the curve are starting to move in favour of the AUD to start the week.

AUD/USD chart

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