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Does the Treasurer want the RBA to match Fed's rate path?

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The widening gap between the US Fed fund rate and the RBA cash rate is putting extraordinary downward pressure on the Australian dollar, the Treasurer has warned.

Speaking ahead of his trip to the United States, where he is due to meet with the chairman of the US Fed Reserve, Treasurer Jim Chalmers warned that the widening gap between the US Fed rate and the local cash rate is putting immense downward pressure on the Australian dollar which carries further implications for inflation.

“I'm not preempting decisions by the US Fed or the Australian Reserve Bank but the mechanics of it are pretty clear,” Mr Chalmers said.

“When there's a big and widening gap between US interest rates and Australian interest rates that risks putting downward pressure on our currency, that makes imports more expensive,” he added.

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Mr Chalmers confirmed this is a topic he plans to raise with the chair of the US Fed, and finance ministers from other economies.

“I think everybody is focused on the same thing, which is what are the implications of the biggest tightening in interest rates around the world that we've seen in modern days, and what that means for our own economies,” the Treasurer said.

“And for Australia, what happens is if there's a big and widening gap between US interest rates and Australian interest rates that puts some downward pressure on the Australian dollar, and that's what we're seeing at the moment as well”.

Last month, the Fed raised its benchmark interest rate by 0.75 percentage points, bringing the Fed rate from 3 to 3.25 per cent. Despite implementing three supersized rate hikes in a row, the Fed said more increases are to come and predicted rates would reach 4.4 per cent by the end of the year.

In Australia, the Reserve Bank (RBA) has embarked on a steep hiking cycle but to a lesser extent than the Fed, bringing the cash rate from 0.1 per cent to 2.6 per cent since May. And although the RBA is expected to keep hiking, AMP’s chief economist, Dr Shane Oliver, expects it to finish up the year at 2.85 per cent.

Treasurer's comments ‘exaggerated’

Speaking to InvestorDaily on Wednesday, Dr Oliver said the Treasurer's comments are “exaggerated” and somewhat confusing.

“Does he mean to say that the RBA should be hiking rates in line with the Fed?” Dr Oliver questioned. 

“Yes, a rising interest rate differential between the US and Australia tends to push the Australian dollar down relative to the US dollar.

“But all currencies have been falling against the US dollar — some like the pound and the Yen more than the Australian dollar,” he said.

Dr Oliver explained that Australia's trade-weighted index for the Australian dollar is only just below its long-term average and has held up well, which means that the potential boost to inflation from the falling Australian dollar is far less than would be implied by just looking at the fall in the Australian versus the US dollar. 

“In any case, the evidence suggests that a 10 per cent fall in the trade-weighted Australian dollar will only add about 1 per cent to inflation over three years which is just 0.3 per cent per annum. And so far, the fall in the trade-weighted index is just 6 per cent which would add just 0.2 per cent per annum to inflation,” Dr Oliver explained. 

“And 40 years ago, we floated the Australian dollar so the RBA can have an independent monetary policy. Rising rates to match the Fed just to keep the Australian dollar up would defeat the purpose of floating the Australian dollar in the first place,” he judged.

Moreover, he warned that the RBA has to take into account that Australia has less of an inflation problem than the US with much lower wages growth.

“Australian households are far more vulnerable to higher rates than US households (because of more debt and short-term mortgage rates) so there is no reason to raise rates as much as the Fed. Doing so would just add to the risk of knocking Australia into recession,” Dr Oliver warned. 

IMF predicts widespread recession

In global news, the International Monetary Fund (IMF) has predicted that more than a third of the global economy will contract this year or next, while the three largest economies — the United States, the European Union, and China — will continue to stall.

In its latest World Economic Outlook, the IMF said, “the worst is yet to come”, and for many people “2023 will feel like a recession”.

The fund’s latest forecast projects global growth to remain unchanged in 2022 at 3.2 percent and to slow to 2.7 percent in 2023 — 0.2 percentage points lower than the July forecast — with a 25 percent probability that it could fall below 2 percent.

The IMF’s concerning forecast is shaped by the lingering effects of three powerful forces: the Russian invasion of Ukraine, a cost-of-living crisis caused by persistent and broadening inflation pressures, and the slowdown in China.

Commenting on the IMF’s sombre outlook, Mr Chalmers said: “The IMF has today warned the global economy is headed for turbulent and uncertain waters — with many economies at risk of slipping into recession, risks of further energy and food price shocks, and debt distress hitting emerging markets.”

“It is clear that there is no easy path ahead. That’s why the October budget will build resilience by delivering responsible cost-of-living relief, invest in our people and our economy, and begin the hard yards of budget repair.”

The IMF’s projections for Australia are a little less worrying than their global outlook, with the fund pencilling in a 3.8 per cent economic expansion in 2022, before GDP is expected to slow to 1.9 per cent next year. It is also slightly more optimistic on local inflation, putting the year-end figure at 6.5 per cent compared to the RBA’s forecast of 7.75 per cent.

Does the Treasurer want the RBA to match Fed's rate path?

The widening gap between the US Fed fund rate and the RBA cash rate is putting extraordinary downward pressure on the Australian dollar, the Treasurer has warned.

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Maja Garaca Djurdjevic

Maja Garaca Djurdjevic

Maja's career in journalism spans well over a decade across finance, business and politics. Now an experienced editor and reporter across all elements of the financial services sector, prior to joining Momentum Media, Maja reported for several established news outlets in Southeast Europe, scrutinising key processes in post-conflict societies.

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