ANZ: Here’s why the RBA may need to change its tune on the Australian dollar

Partially due to persistent weakness in commodity prices, the Australian dollar has remained under pressure throughout the course of 2015.

Against its US counterpart, it’s fallen 12%, narrowly shading the 10% decline registered on a trade-weighted basis.

In response to the continued slide in the currency, the RBA acknowledged in August that the currency was, after remaining stubbornly high earlier in the year, adjusting to significant declines in key commodity prices, weakening the previous language used by the bank that further depreciation was both likely and necessary given the significant declines in key commodity prices.

However, in just the space of two months, the validity of that statement is now being questioned. Partially in response to expectations for a slower rate tightening cycle from the US Federal Reserve, the Aussie has been edging higher, bucking a 20% decline in the spot price for iron ore, Australia’s chief goods export by value.

It does not appear to be adjusting to lower commodity prices any longer. Quite the contrary, in fact. It’s moving higher, even as commodity prices continue to fall.

The anomaly has seen Daniel Breen, currency strategist at the ANZ, question whether the RBA needs to do more to place downward pressure on the currency. As a result of the recent divergence between the two, he suggests the RBA board may change its tact towards the level of the Australian dollar, raising the prospect of change in language towards the currency in this afternoon’s December monetary policy statement.

“While the data pulse over the last month leaves us confident that there will be little change in its tone around the domestic economy, or in its overall bias, there is some chance that the RBA shifts its language on the AUD once again,” wrote Breen in a research note released late yesterday.

Pointing to the chart below, supplied by ANZ, Breen notes that the Aussie has risen over the past two months despite a 20% plunge in the spot iron ore price, suggesting the adjustment to lower commodity prices is no longer taking place.

While iron ore is only one commodity that Australia produces, it is the most influential by some margin. According to the RBA’s own commodity price index, a weighted gauge on commodity price movements key to Australia, iron ore makes up a whopping 34.7% of the index, near triple the next largest component of metallurgical coal at 12.1%.

Given the Australian dollar has risen over the past two months, the 20% fall in the iron ore price has knocked around 7% off the index, negatively impacting revenue for miners and, as a consequence, state and federal governments. It’s a substantial decline, particularly as the index has already fallen 7.8% in the 10 months to October in Australian dollar terms.

It’s clearly important, and as a result may see the RBA look to place further downward pressure on the Aussie, according to Breen.

He notes that while it’s unlikely the board will suggest the currency is overvalued, something it has reverted to in the past, he believes it would be more appropriate given the current circumstances for the RBA to say something along the lines of “recent declines in commodity prices make further depreciation in the AUD seem likely” in its December policy statement.

Given the RBA have already adopted an easing bias – suggesting interest rates may be reduced further should the need arise – more aggressive language towards the currency will see the prospect of near-term rate cuts increase, and weigh on the Aussie as a consequence.

The RBA December rate decision, along with the accompanying monetary policy statement, will be released at 2.30pm AEDT.

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