AUD at Risk if RBA Engages in Macro-Prudential Policy?

Talking Points:

-RBA parsing words on AUD overvaluation in the context of inflation data.

-Higher inflation on the back of rising home values poses challenges for the RBA.

-RBNZ style, non-standard, macro prudential measures to follow?

Last summer as the Reserve Bank of New Zealand struggled with the need to keep rates low under relatively weak data in the context of rising home prices (and thus higher inflation levels), the central bank decided to embark on an unconventional policy of their own. Defined as ‘macro-prudential policy,’ the term refers to a wide range of tools and policies that a monetary institution could put into place in order to curb systematic risk in a domestic economy. These tools have served useful for the RBNZ as their loan-to-value ratio (LVR) restrictions helped curb the rise in home prices since summer and therefor have helped push back the need for rate hikes until just recently. The central bank estimates that the LVR restrictions have been worth up to 50bps of rate hikes that they would have had to implement if not for the macro-prudential policy measures.

As Chinese demand for Australian property continues to push up prices and take inflation along for the ride, questions arise as to the Reserve Bank of Australia’s next move. Only two times over the last two decades have we seen the spread between Australia’s YoY CPI level and the RBA’s cash rate target turn negative. When the last CPI figure came in at 2.7% we saw the third instance of this negative spread occur.

Risks for Australian growth moving forward should not be dismissed as the labor market continues to soften and risks out of her largest trading partner (China) remain large in the second and third quarter. In that context, the RBA is likely to remain cautious in regards to any rate hikes and may take a similar approach as the RBNZ in order to delay those rate hikes. Grant Spencer of the RBNZ recently sat on a panel with RBA Gov. Glenn Stevens in Hong Kong and they discussed central bank policy moving forward. Spencer has been a leading force in advocating for macro-prudential policy as an added tool for central banks and Stevens did in fact praise what the RBNZ was able to accomplishwith the LVR restrictions.

It is important to note that in this context and in regards to possible price action for the AUD if such a path were to be taken, when the RBNZ first announced the LVR restrictions we saw Kiwi weakness for those weeks following. Market participants should continue to watch home price data out of Australia as well as upcoming CPI figures.

Gregory Marks, DailyFX Research Team

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