In a world where nations are supposedly engaged in a “war” to suppress the value of their currencies, Australia appears to be a conscientious objector.
The Australian dollar powered through parity against the US dollar on Tuesday, hitting a high of $1.0023, the strongest level since it was floated in 1983. The jump in the currency followed an unexpected quarter percentage point rise in interest rates by the Reserve Bank of Australia to 4.75 per cent.
The RBA cited tight labour markets, a likely end to moderate inflation and reduced fears of a sharp economic slowdown in China, its main trading partner, for the rise.
The move stands in contrast to that of the Federal Reserve , which is expected to engage in renewed monetary easing to stimulate the fragile US economy after its policy meeting today. It also differs with the positions of the central banks of other relatively small open economies, such as Norway and Sweden, which indicated last week a pause in their monetary tightening.
Sweden’s central bank voiced concerns that overly aggressive monetary tightening could lead to unwanted strength in its currency. The RBA, rather than complain about the strength of the Australian dollar, which has risen 11 per cent against the US dollar this year, says the rising currency will help to contain inflation.
Lee Hardman, at Bank of Tokyo-Mitsubishi UFJ, says: “Australia appears to be one of the only countries which is not overly concerned by domestic currency appreciation.”
The Australian dollar’s strength, he says, has been fuelled not only by widening differentials between Australian interest rates and those of other countries but also by the sharp rebound in commodity prices. There is strong demand from Asia for its raw materials. The RBA said that Australia’s terms of trade were at their highest since the early 1950s.
This, according to Divyang Shah at IFR Markets, suggests that fair value for the Australian dollar is some way higher than parity against the US dollar. “The break of parity is significant from a psychological perspective, but the terms of trade suggest that the Australian dollar is still significantly undervalued,” he says.
Mr Shah says that at a time when the Fed is about to embark on a second round quantitative easing, under which it will buy Treasury bonds to try to drive down borrowing costs and stimulate recovery, and investors are searching for hard assets in which to invest, the Australian dollar will not be short of friends. Central banks and sovereign wealth funds looking to diversify their reserves to protect against further dollar weakness are likely to be among the biggest buyers, he says.
“It is worth keeping in mind that the Australian dollar against the US dollar is the fourth most actively traded currency pair, according to the latest triennial survey from the Bank for International Settlements,” says Mr Shah. “From both a yield and liquidity perspective, the Australian dollar remains an attractive alternative for portfolio managers.”
Many analysts expect more gains for the Australian dollar. Kit Juckes, at Société Générale, believes it will rise to $1.05 against the US dollar. Others are less confident. Stephen Gallo, at Schneider FX, is bearish on the Australian dollar, believing that it will struggle to maintain parity with the US dollar.
This view, he says, in part reflects the fact that investors already hold large long positions in the Aussie. But there is also a growing belief that the strength of the currency is a result of the build-up of unsustainable global imbalances.
During the second and third quarters of this year, Mr Gallo says, the RBA kept interest rates on hold as the People’s Bank of China allowed the renminbi to appreciate. Since mid-October, the PBoC has allowed the renminbi to fall 0.6 per cent against the US dollar, boosting its manufacturing sector and supporting demand for Australian raw materials.
“We could perhaps conclude that a portion of the RBA’s decision to resume rate hikes this early was linked to less aggressive steps by the PBoC to allow its economy to adjust more quickly and let the renminbi rise,” says Mr Gallo.
“It may be the case that foreign exchange market participants know that the build-up of these imbalances is both unsustainable and, if the global political impasse to rectify them persists, destined to end chaotically.” If so, the Aussie might not be the one-way bet it appears.
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