Roger J Kerr assesses the impact of another pivotal change in Australian monetary policy management

In Australia last week, both the bank economists and the financial markets were once again caught wrongfooted on monetary/interest rate policy by the Reserve Bank of Australia (“RBA”).

Following the disastrous bush fires and the outbreak of the coronavirus in January the Aussie dollar was sold down hard from 0.7000 to below 0.6700 against the USD on FX market expectations that the RBA would cut their official interest rates further in response to a resultant softer economic trajectory.

However, the statement last week from RBA Governor Dr Philip Lowe painted a completely different economic picture going forward.

The AUD/USD exchange rate recovered up to 0.6750 on 5 February following the RBA economic update, however, has since slipped back below 0.6700 on a stronger USD on global FX markets.

The initial AUD sell-off was based around plummeting metal commodity prices as Chinese demand would be disrupted by factory shutdowns as a result of the coronavirus pandemic.

The RBA was more upbeat on the Australian economy than widespread prior expectations due to stronger employment growth (forecasting a lower unemployment rate), tax cuts, lower mortgage interest rates, a stronger property market and fiscal stimulus packages.

With GDP growth forecast to go back above 3.00% pa and inflation stable at 2.00%, there is now no justification for further interest rate cuts in Australia according to this latest signal from the RBA. Therefore, a major negative is removed from the AUD outlook against the USD.

Unfortunately, the AUD value will not be priced higher to this new set of monetary policy circumstances until there is more concrete evidence on how much the coronavirus will adversely impact the Chinese and global economies. Once there is evidence that the virus is contained and controlled, the FX market environment will be more conducive to a re-rating of the Aussie dollar higher based on the changed RBA policy stance.

For many months now this column has been far more positive on the Australian economy and thus the AUD/USD exchange rate than the overly pessimistic bank economists.

It is re-assuring that we are now seeing the RBA finally recognise the positive forces for their economy and essentially rule out further interest rate cuts.

However, the justifiably upbeat RBA assessment has not stopped one major Australian bank now confidently forecasting the Australian economy to go into recession as a result of the coronavirus/Chinese economic impact. Given their track record on picking the direction of the Australian economy over the last 12 months, readers should take confidence that a recession is not on the cards.

Kiwi dollar holds steady amongst global uncertainties

The NZD/USD exchange rate stabilised and held firm around 0.6450 for most of the last week, however it fell away to 0.6400 on Friday 7th February as the EUR/USD rate moved below $1.1000 on a stronger USD internationally.

There has been a belated safe-haven rally in the USD on the coronavirus uncertainties and President Trump being acquitted on the impeachment charges in the Senate (as was always going to be the case!).

The Chinese authorities have thrown massive amounts of liquidity into their financial markets to restore confidence and control the economic/financial fall-out from the coronavirus shutdowns.

Time will tell how quickly investor and business confidence can be restored following the still unknown economic impact of the coronavirus situation.

The foreign exchange markets reacted by selling the currencies of economies most reliant on China (Australia, New Zealand and other Asian countries), and therefore it has to be expected that the AUD and NZD will not recover their lost ground of the last two weeks until the economic consequences of the coronavirus are more fully understood.

Tellingly, the People’s Bank of China has not allowed the Yuan to weaken above 7.00 against the USD, therefore further significant weakness in the AUD and NZD does not seem likely.

Whilst Whole Milk Powder prices were down 6.2% to US$3,039/MT at last week’s GDT dairy auction, the price decrease was perhaps not as much as many feared beforehand based on the trade disruptions in China. The current Whole Milk Powder futures do not suggest further price weakness, so additional NZD selling related to falling commodity prices is also not likely. Local jobs numbers released last week were not as positive as expected, however there was no impact on the Kiwi dollar.

The coronavirus pandemic has delivered the global economic uncertainty variable that the RBNZ would have been searching for ahead of their Monetary Policy Statement on Wednesday 12th February. Expect to hear a message that it is “too early to tell what the ramifications will be for the NZ economy; however, overall monetary conditions remain stimulatory and appropriate”. Any expectations of a renewed dovishness from the RBNZ will be disappointed (as the Aussie market was last week).

One mildly positive development from the coronavirus crisis is that it seems to have strengthened the US/China political and trade relationship. China is reducing some import tariffs and there is talk of a phase two trade deal being sooner rather than later.

*Roger J Kerr is Executive Chairman of Barrington Treasury Services NZ Limited. He has written commentaries on the NZ dollar since 1981.