Why the weaker Aussie dollar won’t trigger another RBA hike

If we get a 13th rate hike on Melbourne Cup day, it won’t be because of the recent weakness in the currency. Photographer: Brendon Thorne/Bloomberg

The financial pages have been filled with dire warnings that the recent depreciation in the Australian dollar against the greenback will force the Reserve Bank to hike again.

There are plenty of reasons why the RBA could deliver an unlucky 13th rate rise on Melbourne Cup day – but the currency is not one of them.

In essence, the recent hand-wringing springs from a basic truism that a weaker Aussie dollar is inflationary as it makes imported goods more expensive, all other things being equal.

A retailer, for example, buys stock denominated in a stronger US dollar, and then passes that additional cost on to the customer via higher prices.

Obviously, there’s also the big question of whether the retailer feels able to pass the higher price on without losing too much business, but let’s set that aside.

The Aussie has lost about US6c since mid-July to hit an 11-month low of below US63c this week.

That sounds dramatic, but what matters for monetary policy is not how far exchange rates have moved since the last peak two or three months ago, but how it compares with what the RBA was expecting.

We know that the central bank’s early August economic forecasts assumed a Aussie dollar rate of US66c, or about 3c and 5 per cent above where it trades now.

A fair drop.

The bank’s economic models, however, use an average quarterly currency rate. And over the three months to September the Aussie on average fetched … US65.5c.

Less than a penny difference.

There’s also another aspect that has been lost in the recent coverage: only half of what we buy from overseas, in value terms, is invoiced in US dollars.

The recent global foreign exchange market moves have been a case of the greenback strengthening as US bond yields have shot higher, and every other currency weakening.

This softening in other currencies – the yen, the euro, the yuan – provides an offsetting impact on our import prices.

As mentioned, a bit over half of import invoices are priced in US dollars, and a third in our local currency, according to ABS estimates.

The euro is the next highest proportion, at about 8 per cent.

The closest we can get to a measure of how exchange rate moves could be flowing through to actual imported inflation is via the RBA’s trade-weighted index (or TWI), which “is the price of the Australian dollar in terms of a basket of foreign currencies based on their share of trade with Australia”.

Again, looking back to the RBA’s August forecasts, the TWI was assumed at 61 points.

It is now barely lower at 60pts, and over the September quarter averaged 60.9pts!

It’s also important to remember that the laws of supply and demand offset the impact of currency moves on the cost of goods denominated in US dollars.

Sellers of goods denominated in an appreciating currency will lower their prices to maintain demand and competitiveness. This is most obvious in US-dollar denominated global commodity price markets, where quoted prices move down as the greenback strengthens, and vice versa.

Finally, we can gain some comfort that the RBA is not overly concerned about the recent Aussie weakness by the fact that governor Michele Bullock didn’t say she was.

In 15 years of RBA watching, from the grimly tight mouthed Glenn Stevens to the sometimes over-sharing Philip Lowe, in my experience the central bank talks as straight as possible.

If Ms Bullock and her board believed the Aussie weakening was a real threat to the bank’s inflation forecasts, we would have read it in the statement accompanying this week’s decision to hold the cash rate at 4.1 per cent.

Instead, there were references to “sticky” services inflation, accelerating rental costs, and the recent jump in fuel prices ahead of what could prove a key September quarter consumer price report in a little under three weeks’ time.

There are plenty of things to worry about. For now, at least, the currency is not one of them.