Reserve Bank of Australia Deputy Governor Philip Lowe said a stronger currency and higher savings rate have helped contain inflation and allowed lower interest rates even as the mining industry boomed.
“Somewhat ironically, two of the factors that have created difficult challenges for many businesses over recent years -- the high exchange rate and increased household savings -- are the very same factors that have been critical to Australia’s good macroeconomic performance,” Lowe said in the text of a speech to be delivered today in Sydney. “These factors have helped Australia to digest a huge investment boom without generating substantial imbalances in the economy.”
Australia’s dollar averaged $1.0380 in the past two years, compared with 72.3 cents in the prior two decades, spurred by near-zero interest rates in the U.S. and Japan. Australia’s savings ratio soared as consumers turned cautious after the financial crisis: it was 10.1 percent in the final three months of 2012, from minus 0.1 percent in the first quarter of 2006.
Lowe’s analysis of the higher exchange rate and savings level contrasts with complaints from manufacturers and retailers that have struggled to compete with cheaper imported products and consumers unwilling to spend. The RBA’s No. 2 official repeated that 1.75 percentage points of rate cuts in the 14 months through December are designed to help alleviate pressure from the exchange rate, and added that the currency’s strength was now driving productivity gains in the economy.
“Nowadays, there is a greater recognition that the high exchange rate is likely to be quite persistent and firms, including in the manufacturing sector, are adjusting to this,” Lowe told the Australian Industry Group that represents more than 60,000 firms. “This adjustment in business processes and models is often painful. But the fact that it is occurring is one reason why the Reserve Bank has been tentatively optimistic for some time that productivity growth would pick-up from the low rates experienced over much of the previous decade.”
The RBA has left the cash rate unchanged this year at 3 percent, matching a half century low, as what Lowe called a “once-in-a-century investment boom” in the resources industry is predicted to peak. It is aiming to manage an economy where mining regions in the north and west thrive while manufacturers, builders and retailers in the south and east struggle.
The local dollar’s 53 percent climb in the past four years, the best performance among 16 major currencies tracked by Bloomberg, has hurt exporters.
Lowe today addressed the question of whether the six rate cuts since November 2011 are having the impact expected from such a reduction. He said each easing cycle is different.
“The available evidence does suggest that lower interest rates are doing their work broadly as expected,” he said. “The initial responses to a loosening of monetary policy would be expected to include stronger asset prices, improved conditions in the housing market, a lift in consumer confidence and a lower exchange rate.” He said these appear to be occurring -- noting labor market indicators have been slightly firmer -- with the “notable exception” of the exchange rate, reflecting low global rates and quantitative easing.
Lowe said an improvement in consumer sentiment and higher asset prices should lead to higher household spending. He said the RBA is monitoring non-mining business investment, which is traditionally among the last areas to respond to an easing.
“A critical question for the outlook is the strength of this expected pick-up in non-mining investment,” Lowe said. “There are some tentative signs of a lift in investment intentions outside the resources sector.” He said whether the increases are enough to offset lower mining investment is something policy makers “will be watching very carefully over the months ahead.”
Lowe said the Australian economy has “adjusted pretty well” to the shocks in the global economy and monetary policy has played an important role by keeping inflation “low and stable.” It is committed to continuing that role, he said.
Without the appreciation of the exchange rate, “it is highly likely that the economy would have overheated and that we would have had substantially higher inflation and substantially higher interest rates,” Lowe said. “It is also worth adding that, in any case, it is unlikely that we would have avoided a substantial real exchange rate appreciation, with it coming through the more costly route of higher inflation.”