The Australian Dollar At 80 Cents Gives The RBA A Big Target To Hit

Originally published by AxiTrader

The management of a small open economy with a free floating currency is a difficult task. That's particularly so when that nation has a chronic current account deficit and thus relies on foreign investors for capital. There are just so many competing forces and headwinds that impact how the domestic economy tracks.

Yet this is the task Paul Keating and Peter Costello explicitly handed to the Reserve Bank of Australia in a number of steps beginning with the floating of the Australian dollar in the early 1980's, and the agreement of the inflation target in the 1990's.

And this is the task the RBA has performed with aplomb as it built a track record of 25 years without a recession sailing the good ship Australia through the stormy seas of Asian crises, market funks, and of course the GFC.

A big part of the RBA's success has been its approach to managing the level, and value, of the Australian dollar.

Where many central banks would (and did) fight to protect levels, and keep the Aussie where they wanted it, the RBA, on the other hand, recognised that the volatility in the exchange rate can provide an important stabiliser for growth within the Australian economy.

Just this century the AUD/USD exchange rate has traded through a range of 0.4775 and 1.1080 - 63 cents. And as it traded through this range the Aussie has both stimulated and dampened demand and so overall growth within the economy.

But the level of stimulus or contraction, any given level of the AUD/USD gives to the economy depends on the many other moving parts of the economy.

And that is the very question that the RBA board faces as it sits down today to discuss where the economy is at, where the appropriate level of interest rates should currently be, and what the governor should say about Australia's growth prospects here at home and in light of the global environment.

For some time now the RBA governor has been saying in his monthly statement after each board meeting "The depreciation of the exchange rate since 2013 has also assisted the economy in its transition following the mining investment boom. An appreciating exchange rate would complicate this adjustment".

So even though the Aussie dollar, at 80 cents this morning, is only marginally above the middle of the AUD/USD range, this century the governor is likely to amp up the rhetoric that the exchange rate is providing a handbrake on growth.

Forex traders clearly think this as well. Or at least that is what the price action of AUD/USD relative to EUR/USD - and thus EUR/AUD - suggests over the last couple of sessions.

If governor Lowe soft pedals today we’ll be trading 81.50/82 cents pretty quickly though.

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And from there in an environment where the US dollar is weak, China is still doing relatively well, commodity prices are rallying, risk appetite is still pretty solid, and Australian bond spreads have stopped contracting to their US - and other - counterparts, we could see the Aussie really rocket.

Yes I know that sounds mad. But it's a real possibility the RBA, and Governor Lowe, face if he muffs his lines in the statement following today's expected announcement the bank will hold rates steady at 1.5%.

Looking at the price action now and the charts still suggest the AUD/USD is topping. That's while it stays below last week's high around 0.8060/70. The RBA, and today's Chinese Caixin manufacturing PMI will be important in this respect.

Support is currently 0.7930/35, then 0.7900/05 and 0.7875/80. Topside it's last week's high and then 0.8150.

Here's the chart.