Why a Rate Cut Won’t Clip the Aussie Dollar’s Wings

For those following the usual pre RBA policy decision conjecture would no doubt be aware a cut at today's meeting is odds-on favourite. Interest rate markets are pricing in a strong chance Glenn Stevens and Co will slice off another 25bps from overnight cash rate, and although we would argue these odds are overstated, there is a case to suggest a near-term rate cut is on the agenda.

Firstly what we know is the Reserve Bank is not overly worried about inflation. This is clearly stated in the September policy meeting minutes which notes the domestic inflation outlook provides "scope" to respond to any "significant deterioration in the outlook for growth." This inflation assessment may suggest the board does not deem it essential to wait until further CPI data to be made available before adjusting rates; however it would be wise to assume a fresh take on inflation would be desirable. We can also glean from recent correspondence the RBA has delicately downgraded China's growth prospects by omitting the sentence, "tentative signs that Chinese growth might be stabilising at a more sustainable pace." The bank has also recently acknowledged the implications of the high Aussie dollar, noting the high exchange rate was "weighing more heavily on the economy than might be expected." If we really want to look for more cryptic messages, the last policy statement brought the time element into the equation, stating "At today's meeting" the stance of monetary policy remained appropriate. Although clutching at straws, this may suggest the decision may have been more finally balanced then the statement suggested. So with a domestic economy suffering under the weight of a high exchange rate, a softer Chinese growth outlook and ongoing dramas from both sides of the Atlantic, there is a case to suggest the RBA may undergo precautionary easing.

Nevertheless the question remains, will the Reserve Bank cut rates in effort to soften the Aussie dollar, and more importantly will it work? We believe the answer to both questions is a resounding no. Despite growing calls to do so, history suggests the RBA does not seek to influence the exchange rate (at least publicly) by lowering the cash rate or by direct intervention for that matter. Although it may produce an immediate burst of weakness, it's important to remember the Australian dollar is representation of a strong economy in comparison to global counterparts. Unless the board decide to embark on an aggressive series of interest rate cuts, Australia's yield advantage assures the Aussie dollars risk credentials will remain firmly intact, rendering the local unit at the mercy of global risk trends not tentative prospects of policy tweaking. Despite a possible rate cut today, the Aussie's performance will remain contingent on global market sentiment and of course highly reactive to policy changes abroad, namely the Fed's latest QE effort. We only need to look to Japan to understand the hazards of rowing against the rapids, and the RBA are all too aware of the implications of such a move.

While we can construct a case today's decision will be finely balanced, it won't be an effort to directly influence the exchange rate - this alone minimises the chance of preemptive action at today's meeting. At the time of writing the Australian dollar is buying 103.55 US cents.