Australia: Manipulating by not Intervening?

The Wall Street Journal brings to our attention the fact that the reserves at the Reserve Bank of Australia have risen sharply over the past two months.   Its reserves have risen by A$863 mln over the past two months after rising by about A$147 mln in all of Q2.

Typically when reserves increase, it is due to action by the central bank. However, as the Wall Street Journal points out, this is not the case in Australia.  Its reserves rose due to the inaction of the RBA.  It simply did not convert the foreign currency inflows as it typically does.

   

Yet report claims that this inaction itself is tantamount to intervention.  We demur.  The claim collapses an important distinction between passive and active reserve accumulation.   It risks obscuring the distinction between managing and manipulating.  Its equivalency claim conflates reserve management with intervention.   The absence of intervention becomes another type of intervention.   

Nevertheless, the signal is clear and the RBA has been explicit.  Its currency is too strong.  Not only have some board members expressed an interest in a weaker currency, but the RBA cited the Australian dollar's strength as an important consideration behind the rate cut earlier this month.  On a trade-weighted basis, the Australian dollar has risen another 2% in recent weeks.  The value of the WSJ piece is not in its claim about intervention, but showing another way in which the RBA is demonstrating its displeasure with the Australian dollar's strength.  

Economic data since the RBA meeting has been mixed.  On one hand, it has reported a much larger trade deficit and softer retail sales.  On the other hand, auto sales, house prices, employment and CPI were firmer than expected.  

The global headwinds have not changed very much.  The euro area likely contracted in Q3 and that contraction appears to have carried over into Q4.  China's economy may have bottomed in Q3, but a wide berth is needed given the suspect nature of Chinese economic data.  The US economy appear fragile as the fiscal cliff is approached and within yesterday's durable goods order report, a sharp slowdown in capital expenditures has caught the attention of many observers.  Nor is next week's employment data expected to be particularly robust.  

The case for another RBA rate cut remains intact.  The changed behavior of the RBA in dealing with its fx inflows reflects its frustration with the persistent strength of the Australian dollar.  Even with 2% year-over-year inflation in Q3, Australia offers relatively high real interest rates and will continue to do so even if the RBA cuts the cash target rate in early November from 3.25%.  

In addition to its relatively high interest rates, easily the highest in the G10, central banks adding Australian dollars to their reserves is another supportive factor.  The RBA's decision to allow foreign currency balances to build is a modest offset.  Modest because the RBA's reserve increase seems minor (less than $1 bln over two months) compared with the number of central banks that have indicated they were diversifying some of their reserves into Australian dollars.

Against the dollar, the Aussie reached a 6-7 month high in mid-September near $1.0625.  By early October it had been sold down to around $1.0150.  It has recovered, but has faltered near the 50% retracement, which comes in just below $1.04.  This area marks resistance now having failed twice.  On the downside, trend line support drawn off this month's lows comes in near $1.0265.