Economic and Financial Market Update: Interest Rates And $A Marking Time


  • The Australian economy will be stronger at the end of this year than it started;
  • But there remains ample spare capacity in the economy
  • The RBA will be wary about reducing monetary support too early;
  • I doubt we have seen the peak of the $A in this cycle;
  • My ‘simple’ model had ‘fair value’ for the AUD at 80c at the end of last year.

Last year the RBA indicated that both a notable reduction in the unemployment rate and inflation moving sustainably above 2% would be important milestones for any monetary policy change. Wage rises of at least 2.5-3% might be another sign that the unemployment rate has fallen to a low enough level.

The other key test is inflation. The bottom line is that aggregate inflation is very low, meaning the economy will have to grow very strongly for some time before the CPI will (sustainably) return to the RBA’s 2-3% target.

I think that the RBA will look to increase interest rates when the unemployment rate is closer to 5.5%, wages growth is at least 2.5-3% and (underlying) inflation of 2% (or above) for two consecutive quarters. At the time of writing financial markets were pricing in a good chance of a quarter percentage point rate hike some time in 2023. I think that timing might be a bit early. Mostly that is because as Deputy Governor Guy Debelle pointed out one of the lessons from the GFC is be careful of removing stimulus too early.

Exchange rate movements in the year to date have (mostly) been limited. The lack of significant currency movement reflects that most economies are being driven by similar factors. Another reason for the more limited moves is that the $US has moved from being very over valued in the first half of last year to modestly over valued by year-end.

The $A has been mainly trading in a 77-78c range so far this year, although it had dipped below that range at the time of writing. By the end of last year my simple model of the $A suggested that ‘fair value’ was around 80c. The recent move below 77c though is a sign that the Aussie does not want to head higher right now.

But I doubt that we have seen the high of the $A in this cycle. The combination of lockdowns and the vaccine rollout will likely see the major economies get on top of the virus by mid-year. In that event providing commodity prices stay high and financial market volatility low a break of 78c is possible, and would see the $A hit 80c (and maybe as high as 81c). 



To read my full update, click here.


We live in interesting times!


Peter Munckton - Chief Economist