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David Brown

The Reserve Bank of Australia has a problem on its hands. Interest rates are too low, the economy is getting pumped up and there are signs speculative bubbles forming. It is clearly time to be raising rates.
But that is the last thing the central bank needs for the Australian dollar now, which is already strong enough as far as it is concerned. The faintest whiff of higher rates could launch the currency into a new phase of unbridled strength.
The aussie is a quicksilver currency. If the climate is right, buying the aussie can be a lucrative, self-fulfilling one-way bet for currency bulls, thanks to its natural appeal for investors hungry for higher yields in global foreign exchange markets.
While RBA rates are far below the 7.25 per cent cyclical peak hit just before the global financial crisis broke in 2008, the 2.5 per cent official cash rate offers a substantial premium over near-zero interest rates in the United States, Japan, the euro zone and Britain - the so-called G4.

This differential could grow larger still in coming months as Australia's economic recovery cycle picks up momentum.
The RBA is doing what it can to put the markets off the scent of higher rates. It is sticking to a script that insists current rates remain appropriate "for some time yet". Significant global headwinds, a surfeit of domestic slack and the loss of momentum in a mining boom are all good reasons to keep policy steady.
So far, it is having the desired effect. Market expectations for future rate tightening remain reasonably dovish. Consensus forecasts expect the RBA to delay its tightening until the first quarter of next year. A small minority of pundits even think it might cut rates once more in this cycle.
Interest rate dynamics point the other way. In fact, higher rates could come a lot sooner than expected.
Australia's growth prospects are not only sound, they look positively rosy. The domestic recovery is doing well. Gross domestic product is expected to expand 2.75 per cent this year, with 3.25 per cent forecast for next year.
Unemployment appears to have peaked, with job creation already moving back into strongly expansive territory. In the past two months, employment gains averaged about 30,000, close to peak activity levels attained during the boom years.
This is feeding into the housing market, with prices in metropolitan areas rising about 10 per cent - a bullish rate that will soon sound alarm bells at the central bank.
Consumer inflation, meanwhile, accelerated to 2.9 per cent in the past few months, within the RBA's 2-3 per cent target band.
Inflation dynamics are far from passive. Domestic demand is picking up and import price inflation is accelerating. As faster recovery re-engages, the combined impact of cost-push and demand-pull factors will breach the RBA's target very quickly.
New Zealand offers a timely illustration of how quick this change could come.
In March, it became the first developed economy to raise interest rates from the record lows they have sunk to in the wake of the financial crisis. It raised again last month and another increase of a quarter percentage point is likely next month. It is a reminder that Australia is living on borrowed time with the key rate as low as 2.5 per cent.
The Australian dollar also has well known positive market correlations with key global indicators - such as faster world trade, booming commodity prices and rising equity prices.
There are signs the world economy is cranking up into a higher gear.
The US and British economies are speeding up, with growth running upwards of 3 per cent. Abenomics seems to have turned the key for Japan's long overdue recovery. The euro-zone downturn seems to be bottoming out. And China's growth "slowdown" seems to have stabilised.
The odds are that global growth has not only turned the corner to better times, but - with G4 central banks seemingly reluctant to step on the policy brake too soon - a super-charged recovery looks set to follow.
This has an important message for faster world trade growth, a strong recovery in commodity prices and a strengthening in global equity markets. All these factors would complement a stronger Australian dollar.
It would signal a return to strength for Australia's mining and resource industries - with important feedback loops for faster domestic recovery, higher rates and self-sustaining dollar demand.
Future aussie gains may be more limited against the US dollar and British pound, now breaking free of currency-debasing quantitative easing programmes. But, with Japan and the euro zone still open to additional monetary measures, the yen and euro could crumple in front of a fired up aussie.
David Brown is the chief executive of New View Economics


Australia faces currency dilemma

Faster world trade, booming commodity prices and rising equity prices are pointing the direction for the Australian dollar. Photo: Bloomberg

Business

Economy

Global Economy

Low interest rates, a rebounding economy and speculative bubbles are putting pressure on the reserve bank to keep the currency from rising


The Reserve Bank of Australia has a problem on its hands. Interest rates are too low, the economy is getting pumped up and there are signs speculative bubbles forming. It is clearly time to be raising rates.


Australia faces currency dilemma

.css-1c6uqr6{color:inherit;font-weight:inherit;font-size:inherit;font-family:inherit;line-height:inherit;overflow-wrap:break-word;}Low interest rates, a rebounding economy and speculative bubbles are putting pressure on the reserve bank to keep the currency from rising

Low interest rates, a rebounding economy and speculative bubbles are putting pressure on the reserve bank to keep the currency from rising