The RBA has cut Australian interest rates to a record low of 1 percent in an effort to boost inflation. The Australian dollar is slightly stronger following the widely expected decision but is expected to lose 5–7 percent of its value before year-end.
If ever proof was needed that foreign exchange markets price in economic developments ahead of time, it came on Tuesday when the Australian dollar strengthened after the Reserve Bank cut interest rates to a record low of 1 percent.
The RBA’s decision to cut rates for a second consecutive month induced an AUD rally from levels near US$0.697 to US$0.699. Against the New Zealand dollar, the Aussie leapt away from 3-month lows to levels just shy of NZ$1.05, and it even struck a 4-month high of £0.554 against the pound, albeit briefly.
Although the Aussie displayed strength following what should have been a bleak development (Australian interest rates are now the seventh lowest in the world), it was the worst-performing major currency on Monday and lost value throughout much of June, which demonstrates that the RBA’s decision was entirely priced in and that FX traders adjust positions and portfolios weeks and months in advance of big events.
“Buy the rumour, sell the fact,” as traders so often say — or in this case, the reverse.
Cheaper credit in Australia is warranted, economists believe, to stabilise the domestic economy and to get inflation humming back near its medium-term target, as well as to lend support to businesses which are reluctant to invest amid a US-China trade standoff that threatens Chinese demand for Australian commodities.
In a statement, RBA Governor Philip Lowe hinted that interest rates would be left at this record-low level for several months but said that policymakers were “prepared to adjust interest rates again if needed to get us closer to full employment and achieve the inflation target.”
“We will be closely monitoring how things evolve over coming months,” Lowe said.
Economists continue to predict a further rate cut this year and many are predicting two further cuts by early 2020.
This game of economic catch-up at the RBA is the result of a number of “errors and misjudgments” made by policymakers in 2018, writes PerCapita economist Stephen Koukoulas, and these errors include a “starry-eyed” view of the economy, a willingness to use monetary policy as a brake on house prices and an incorrect assumption that steady interest rates mark financial stability.
Inevitably, the Australian dollar will continue to track changes in expectations for future interest rates and for these “the unemployment rate will be a key indicator” going forward, says Fidelity’s Anthony Doyle.
A number of AUD forecasters continue to expect the Aussie between 5 and 7 percent weaker at year-end, at rates between US$0.65 and US$0.665. Exchange rates near the lower of these levels would take the currency’s losses to 20 percent since a high of US$0.813 was struck in January 2018.