Reserve Bank plays down exchange rate concerns as Australian dollar lifts against US dollar

The Australian dollar’s 12 per cent year-to-date fall against the US dollar is spurring market discomfort over inflationary impacts.

The Reserve Bank has played down concerns about the inflation impact from a falling Australian dollar as its depreciation against currencies other than the US dollar this year isn’t significant.

In a speech on “Exchange rates and inflationary pressures” at CBA’s Global Markets Conference in Sydney, RBA Assistant Governor Financial Markets Chris Kent, said the inflation impact of a roughly 2 per cent fall in the Australian dollar in trade-weighted this year is “estimated to be relatively modest”.

“The smaller depreciation of the Australian dollar in trade-weighted terms than against the US dollar is important because the TWI typically has a greater bearing on our imported inflation than any one bilateral rate,” Mr Kent said.

“A rough rule of thumb from our models suggests that the level of the Consumer Price Index will be higher by only around 0.2 per cent in total over the course of a few years.”

It comes amid concern that the Australian dollar’s 12 per cent year-to-date fall against the US dollar this year will add to domestic inflation already running well above the RBA’s 2-3 per cent target.

The RBA’s most recent forecasts in August predicted that Australia’s inflation rate would peak at 7.8 per cent in December.

The RBA’s most recent forecasts in August predicted that Australia’s inflation rate would peak at 7.8 per cent in December.

In his speech, Mr Kent reiterated recent RBA communications that the bank expects to “increase interest rates further in the period ahead, given the need to establish a more sustainable balance of demand and supply and in the face of a very tight labour market.”

But he noted that while wages growth has picked up in Australia from the low levels of recent years, it remains lower than in many other advanced economies.

“The size and timing of rate increases in Australia will depend on incoming data – including the response of household spending to the tightening in financial conditions,” Mr Kent said.

The US dollar’s rise in trade-weighted terms this year, is “consistent with the rapid rise in US interest rates relative to those of many other economies, including Australia”, he added.

But while noting that the depreciation of currencies against the US dollar will “add some pressure to already high rates of inflation in a wide range of advanced and emerging economies via a rise in the prices of imported goods and services”, he said higher US interest rates will “help to stem the growth of US demand for goods and services.”

“The US economy accounts for about 25 per cent of the global economy … so an easing in demand pressures in the United States will help to ease a noticeable portion of global demand,” he said.

“Second, when most of the world’s currencies depreciate against the US dollar, households and firms in those economies will not be as willing nor able to pay the same US dollar denominated prices for their imports.

“Hence, we could expect those prices to decline, or at least rise less rapidly, over time.”