Australia’s official cash rate has never been this far below its American equivalent.
It’s a measure of the extraordinary times in which we find ourselves that this landmark didn’t raise much more than a lazy eyebrow among investors and central bank officials alike.
On Thursday morning chairman Jay Powell announced what everyone had been expecting: a further lift in the official Fed funds rate to 2.25 per cent. (Fed officials actually target a 0.25 percentage point range, so this is what is referred to as the “upper bound”.)
It was the eighth official US rate hike in under three years. The Reserve Bank, in comparison, has engaged in a lengthy period of “masterly inactivity” and kept its cash rate target at 1.5 per cent for over two years. The RBA actually cut in May and August of 2016.
Thursday morning’s decision means US official rates are now 0.75 percentage points higher than than their Aussie counterparts – the widest since the RBA began targeting inflation in the early 1990s. The gap turned negative in March of this year for the first time since 2000. By June the difference had extended further to 0.5 percentage points – equal to the previous record that prevailed over much of the three years from July 1997.
Earlier this year there were some low-key worries around the significance of a negative rates differential. Towards the beginning of the millennium the Aussie dollar sunk as low as US50¢, raising some admittedly half-hearted questions around whether something similar was about to happen.
Today, those worries of a currency collapse seem misplaced, thanks in large part to the steadying influence of resilient coal and iron ore prices. The dollar has come back sharply since peaking at US81¢ in January, but looks pretty steady now at US72.6¢.
As the gap between our two policy rates yawns ever wider over the next year or two, downward pressure on our currency is likely to build.
On Bloomberg market pricing, a year from now the US Fed wil have hiked twice more while the RBA is more likely than not to have stayed put as it patiently awaits wages and inflationary pressures to build.
Westpac see the rates differential as an under appreciated drag on the Aussie, but the bank’s economists still only expect the currency to reach its weakest of around US70¢ in the first half of 2019. Forecasts from Capital Economics predict a heftier fall to as low as US65¢ by the end of next year.
But is this bad news? Certainly not. Policymakers welcome a weaker currency. The official RBA position is that a lower Aussie is “helpful for domestic economic growth”.
And governor Philip Lowe as recently as February reiterated the view that the RBA felt zero pressure to follow peers in the US and Canada and lift rates. The cash rate may be at a record low of 1.5 per cent, but the mining investment boom helped insulate us from the worst of the global financial crisis and that meant we didn’t cut as far or as fast as others.
“Just as we did not move in lock-step on the way down, we don’t need to do so in the other direction,” Lowe said.
Deputy governor Guy Debelle expanded on the theme in a speech in July of last year. He spoke of lower “neutral” policy rates here and abroad – the level at which monetary policy is neither restrictive or accommodative.
“This means that the current cash rate setting of 1.5 per cent today is not as expansionary as a cash rate of 1.5 per cent would have been in the 1990s or the first half of the 2000s,” Debelle said.
Not as expansionary, but still expansionary.
Meanwhile, on Thursday morning the Fed removed its reference to monetary policy as being “accommodative”, underlining how powerfully our two countries’ monetary policy cycles have de-synchronised.
While the impact of this has so far proved minimal, we are only very early into the exit from a decade of unprecedented central bank intervention.
It seems like everyday financial markets make history in some way or another; Thursday morning’s record rates differential was only the latest. And it’s only in retrospect will we know which were the meaningful ones.