The US Federal reserve has increased the US official interest rate by half a percent. This presents the board of the Australian Reserve Bank with a quandary when it meets next month. Does it follow suit just because the US has increased its rate, or does it make a judgment independent of US conditions? If Australia does not increase its rate in line with the US increase, it is inevitable that Australian dollar will fall as investors depart for investment in more lucrative US markets. If is does increase the rate in line with US markets, the Australian currency may hold, but it will be an artificial holding up of the currency. It would be as foolish as gong back to the old days of a pegged rate. It may be that conditions in Australia warrant an increase in the interest rate for reasons aside from what has happened in the US. If so, all well and good. But that is unlikely to be the case. The Australian economy is performing differently form the US economy. It is not growing as fast. Nor does it have the same inflationary and wage pressures as the US economy.
The important thing here is for the Reserve not to act on the basis of the US economy. True, Australia needs foreign investment to ensure our balance of payments stays in control. However, it would be folly to increase interest rates on that basis alone if it meant that the brakes were applied to the Australian economy with excessive force. The Reserve needs to look at the Australian currency in a global context. While it looks poorly against the US dollar, so are other currencies. Indeed, the euro is doing worse against the US dollar than the Australian dollar is.
The Reserve should also be wary of the predictions and reasoning of the market gurus. Less than a year ago they were predicting that that Australian dollar would climb into the high 60s or possible 70 cents US in 2000. It may well be that many bought Australian dollars upon the basis of those predictions and as they now try to unload, they are putting pressure on the Australian dollar. One of the difficulties for the Reserve is that the Australian dollar is a highly traded currency. The level of trade in the Australian dollar is far higher than the volume of trade into and out of Australia would otherwise warrant. Nonetheless, that is a problem for those who trade in the currency market – usually people based overseas. The Reserve’s primary duty is to Australians, not foreign currency dealers. It should avoid the risk of unnecessarily slowing growth and increasing unemployment in an attempt to keep the Australian dollar high in relation to the US dollar just for the sake of it. Part of the trouble is emotional. People want a “”strong” currency. If the dollar falls, some national pride seems to be at stake. These factors should be ignored. It is more important that interest rates are not increased to the extent that economic activity is adversely affected.
If the US economy performs well and its reserve feels its interest rates should rise, so be it. Australia should let market forces do their work and let the Australian dollar fall against the US currency. Previously rises predicated against rises in US rates seems to have done nothing to hold the currency anyway. Far better to let the Australian dollar fall than induce and unnecessary economic slump in Australia. A lower Australian dollar will help exporters, make imports cost more and be more expensive and will ultimately self correct on the basis of Australian productivity. Otherwise, the Australian dollar will be unsustainably high and will fall anyway, irrespective of Reserve Bank increases in interest rates.