There is no secret pact between central bankers to talk about tighter monetary policy after all. The Reserve Bank of Australia was unmoved on Tuesday, keeping cash interest rates at 1.5 per cent and the language of its announcement studiously neutral. In the space of an hour the Aussie dollar dropped 0.7 per cent to 76 American cents.
Few had expected the bank’s board to increase what is, by the standards of developed country monetary policy, a generous short-term rate of interest. Yet the Australian economy, 26 years into the miracle of a recession-free expansion, is expected to grow another 2.6 per cent this year. Markets have spent the past two weeks reacting to central banks talking up the possibility of a more restrictive approach, so a change of tone or language would have fed the narrative of co-ordinated action.
Instead two conclusions stand out, first of which is the central role currencies are likely to play as policymakers try to finesse the impact of their words.
The Reserve Bank has long said that Australia benefited from a weakening currency after 2013, and that a stronger dollar would complicate attempts to adjust to life after a mining boom. The effect matters ever more so now that foreign exchange markets have become the fastest and clearest indicators of bets on monetary policy.
In the past two weeks, the Canadian dollar has jumped most against the dollar among the commonly traded developed world currencies, up 2.6 per cent, after policymakers signalled that the first rise in interest rates in seven years was imminent. A stronger currency, however, can hinder a fragile economic recovery, rendering policymakers’ plans moot. The logic of simultaneous action across central banks is in part to avoid sticking out.
The second is a reminder that wage pressure, a crucial factor in the acceleration of price inflation, remains absent in Australia and elsewhere. While the Reserve Bank said employment continues to grow, it added a caveat which should be familiar to American and European ears: “Wage growth remains low, however, and this is likely to continue for a while yet.” Markets have been behaving as if higher inflation and tighter policy is just around the corner, but evidence for the former is not quite there yet.