Australia’s exchange rate is “uncomfortably high” and business confidence subdued, breaking with past experience during interest-rate reductions, Reserve Bank Deputy Governor Philip Lowe said.
“Countries that are in relatively good shape and have not seen large-scale expansion of the central bank balance sheet are experiencing stronger currencies than those that are in relatively poor shape,” Lowe said in a speech yesterday in Sydney. “In response to this, interest rates are lower than they otherwise would be to offset some of the effects of an uncomfortably high exchange rate.”
Lowe highlighted a split between Australian households, where data have “picked up somewhat” in response to 1.75 percentage points of rate cuts in the past 14 months, and businesses, where confidence and conditions have not. “This difference will obviously bear close watching over the period ahead,” he said.
The No. 2 RBA official’s speech titled ‘What Is Normal?’ sought to place Australians’ higher savings and lower retail spending, as well as stagnant asset prices in the context of the economy’s performance of the past 30 years. He said consumers were “prudent” rather than “cautious” and indicated that their behavior was simply returning to pre-boom levels.
The RBA lowered rates six times in the past 14 months to 3 percent, matching a half-century low reached at the height of the 2009 global recession. Lowe said it is possible that lending rates will be “somewhat lower” for a period, reflecting global weakness and fallout from the credit boom last decade.
The Australian dollar has risen 7.4 percent in the past six months. Lowe said the sustained strength wasn’t unexpected.
“This is one of the mechanisms through which the weak conditions in most of the advanced economies are transmitted to the rest of the world,” he said. “Many of the countries that avoided the financial crisis are experiencing uncomfortably high exchange rates and low interest rates. Australia is one of these.”
Resource investment to meet Chinese demand and foreign investment funds seeking a haven have spurred gains in the currency. The Aussie has averaged about $1.03 in the past two years, compared with about 73 U.S. cents in the prior decade.
Responding to audience questions, Lowe said the central bank had factored in much of the lower projections for business spending in the fiscal year that were revealed in a capital expenditure report last month. He said resource investment was likely to “plateau” in the first half of next year.
He reiterated comments he has made this year that while the central bank doesn’t rule out intervention in currency markets, it would be a big step to take.
“The floating exchange-rate regime has served us very well,” Lowe said in response to a question. “So we wouldn’t rule out intervention but it would be a very significant step to take and quite a departure from the set of arrangements that have served us so well for so long now.”
Asked about the threshold for unconventional monetary policy, Lowe said hypothetically it would be “around 1 percent, plus or minus a bit,” or a long way from where policy is now.
The failure of the RBA’s monetary easing to spur an upswing in industries outside of resources has led to questions about the effectiveness of the nation’s monetary policy transmission. Lowe said the current response to lower borrowing costs was in line with past experiences.
“Monetary policy still looks like it is working,” he told the Australian Business Economists forum in his prepared remarks. “There are lags and different parts of the economy respond differently, but lower interest rates are still effective in providing a boost to the overall economy.”
Lowe said Australia can extend its 21 recession-free years, saying it is “well placed” to benefit from growth in Asia because of the nation’s skilled workforce.
“Whether we can take advantage of the opportunities that lie ahead and continue to enjoy the rate of increase in our living standards that we have become used to depends upon productivity growth,” he said. “The contribution the Reserve Bank can make here is to maintain low and stable inflation and to keep the economy on an even keel.”
A government report scheduled for release today may show Australia’s unemployment rate rose to 5.5 percent in November, according to the median estimate in a Bloomberg survey of 27 economists. That would be the highest level since April 2010.
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