Last week we wrote about the near-term upward pressure on interest. We pointed out that over the month through to Monday last week Australia’s 2-year government bond yield had risen by 14bps to 1.69%, while the 10-year bond yield was up 23bps to 2.19%. Over the past week the 2-year and 10-year bond yields have risen further to respectively 1.74% and 2.31%. The continuing rise in interest rates in the near-term is consistent with the themes of the economy doing a little better for the time being; the likelihood that the RBA will take its time before considering another cash rate move; and the growing probability the US Federal Reserve will hike its funds rate by 25bps in December. The movement upwards in bond yields over the past month or so, especially if it continues as we expect, will place upward pressure on bank funding costs is likely, in our view, at some stage to push the banks to lift their lending interest rates.
This is one part of the story of the inadvertent tightening of monetary policy that occurs when the RBA is not doing anything with its cash rate. Higher bank lending interest rates still have the same dampening impact on demand for loans regardless of whether the precipitating factor was or was not a cash rate hike delivered by the RBA.
Another part of this unplanned tightening of monetary conditions is what has been happening to the Australian dollar exchange rate. The Australian dollar has mostly been appreciating since the middle of 2016, even against the US dollar which itself has been an appreciating currency.
Three factors appear to have lifted the Australian dollar. Export commodity prices have been quite firm, up around 4% in Australian dollar terms between the end of June 2016 and the end of September 2016. Australia’s GDP annual growth at 3.3% y-o-y in Q2 2016 is relatively strong by the standards of most other OECD economies. Australian interest rates, although low by historical standards are high by international comparison. So attractive was Australia’s recently issued 30-year government bond that two-thirds of the offering was taken up by foreign investors.
Since the end of June, the Australian dollar has appreciated 2.1% against the US dollar but rather more against the currencies of our two biggest trading partners, China – up 3.3% against the renminbi – and Japan – up 3.5% against the yen. One currency that has depreciated considerably over recent months is the British pound amid the uncertainty about the form of Brexit and how much it may harm Britain’s economy. Since the end of June, the Australian dollar has appreciated 12.0% against the British pound, although if the calculation is taken from just before Britain’s Brexit referendum the appreciation is 26%.
On a trade weighted basis, the Australian dollar is up 3.2% since the end of June. Rather like the more recent lift in bond yields, there seems little to stop the Australian dollar from appreciating further in the near-term. This may seem a bold call as a great deal of key economic data is due out from our single biggest trading partner China this week, including their Q3 GDP report. Any untoward weakness in China’s economic readings could briefly cut in to Australian dollar strength, but it would probably be the briefest of wobbles as the most likely policy response from China’s authorities to softer-than-expected data is likely to be intensification of its efforts stepping down the renminbi exchange rate.
The rising Australian dollar provides over a time a dampening influence on Australian exports of goods and services while priming demand for relatively cheaper imports of goods and services. Place that currency appreciation effect together with rising lending interest rates and the total combined effect amounts to a quite marked tightening of monetary conditions.
Unless this tightening of monetary conditions is reversed it is likely to work to dampen economic growth. This is where the approaching November 1st RBA board meeting is a very important one determining what may happen to the general economic growth outlook. The RBA is giving strong signals that it wants to wait before adjusting its cash rate any further. The problem is that a pass at the November 1st meeting could easily reinforce upward pressure on Australian bond yields and the Australian dollar. In effect a pass becomes a de facto policy tightening.