Slide in Aussie dollar threatens RBA rate cuts decision

Just as the possibility of a pre-election interest rate relief has come into view, depreciation of the Australian dollar risks keeping the cash rate higher for longer.

Reserve Bank governor Michele Bullock. Picture: NewsWire/Martin Ollman

The Australian dollar’s depreciation to a near-five year low poses a fresh inflation risk for the Reserve Bank, just as the possibility of a pre-election interest rate cut has come into view.

The drop in the local currency comes ahead of fresh employment data released on Thursday and could act as a barrier to interest rate cuts, as soaring jobs growth in the care economy is expected to have held the jobless rate at just 4 per cent in December.

During Friday’s trading, the Australian dollar fell to US61.38c against the greenback, its lowest level since March 2020.

The weakness in the local currency has pushed up the price of imported goods, such as petrol, and added to the case for the RBA to hold off on an interest-rate cut at its next board meeting, scheduled for February 17-18.

Critically for the RBA, the Australian dollar has similarly depreciated when measured against the central bank’s favoured “trade weighted index” – calculating its value against a basket of foreign currencies weighted by their trade with Australia – which on Friday also fell to a 15-month low.

At the same time, exchange traders have ramped up their bets that the Australian dollar will slump further, positioning for a fall below the US60c level, following signs of a further retreat in inflation and the looming threat of a sharp increase in tariffs under president-elect Donald Trump.

Betashares chief economist David Bassanese said the depreciation in the Australian dollar would be causing discomfort for the RBA, tipping a quarter-­percentage-point interest rate cut at its May board meeting, which would take the cash rate to 4.1 per cent.

“One of the reasons I expect a hold will be because the Aussie dollar has been weakening,” Mr Bassanese said, warning that the currency could come under further pressure if the central bank pressed ahead with rate cuts in February. “Inflation is still higher than the Reserve Bank would like and it would certainly be uncomfortable that rate cuts could be another source of inflationary pressure in the short run.”

Former RBA assistant governor Luci Ellis, now chief economist at Westpac, said while the depreciation of the Australian dollar had driven up the cost of petrol and travel to the US, its impact on domestic inflation would be marginal. “Short-lived moves in exchange rates tend not to flow through to domestic prices,” Dr Ellis said, arguing a souring economic outlook for China, our largest trading partner, was weighing on the domestic currency.

The depreciation of the dollar against the greenback, which has been under way for several months, also owes to a different outlook for interest rates between Australia and the US.

Markets are fully priced for three rate cuts by the RBA this year, but anticipate just one cut by the US Federal Reserve.

Consumer price data released last week raised expectations of an interest-rate cut at the RBA’s next board meeting after it showed the central bank’s preferred under­lying gauge rose by 3.2 per cent in the 12 months to November, nearing the top of its 2 to 3 per cent target band.

Weaker-than-expected retail and household spending figures also raised the chance of a February rate cut, with money markets ascribing odds of a move lower next month at 75 per cent.

Markets are fully priced for an April rate reduction.

A rate cut before the federal election, which must be held on or before May 17, would bolster the government’s economic credentials and provide relief for household borrowers in mortgage-belt swing seats who have weathered 13 rate hikes since May 2022.

Despite threatening the prospect of rate cuts, a weaker Australian dollar is expected to bolster the budget bottom line as it en­ables exporters to price their products more competitively overseas and receive payment in more valuable foreign currencies.

Alongside the stronger jobs market, still elevated prices for key commodity exports, including iron ore, have boosted income tax receipts, which were running more than $9bn ahead of forecasts in the five months to Nov­ember 30, according to Finance Department data.

Consequently, the federal budget recorded a deficit of $14bn over the five month period, the figures show, far smaller than projections in the May budget of a $28.5bn deficit at the end of November.