RBA’s Kent: Middle East conflict poses inflation and economic risks
The Reserve Bank of Australia (RBA) Assistant Governor Christopher Kent warned that if the Middle East conflict prolongs, the economic damage would be greater and policymakers would need to cap inflation amid surging energy prices.
In a speech in Sydney, he said that the Iran war tightens financial conditions but also increases the risks of an inflation spiral.
Key takeaways:
WE WILL CONTINUE TO ASSESS THE COUNTERVAILING FORCES OPERATING ON THE ECONOMY
BOARD WILL SET MONETARY POLICY TO ACHIEVE LOW, STABLE INFLATION AND FULL EMPLOYMENT
THE LONGER THE CONFLICT PERSISTS, THE LARGER THE ECONOMIC IMPACT WILL BE
THIS COULD PUSH SHORT-RUN NEUTRAL RATES HIGHER, NECESSITATE MORE RESTRICTIVE POLICY
NEED TO ENSURE INITIAL RISE IN PRICES DOES NOT LEAD TO RISE IN LONGER TERM INFLATIONARY EXPECTATIONS
THIS IMPLIES A DECLINE IN SHORT-RUN NEUTRAL RATES HERE AND OFFSHORE
MIDDLE EAST CONFLICT HAS LED TO SOME TIGHTENING IN FINANCIAL CONDITIONS
HOWEVER, THE SUPPLY SHOCK ALSO POSES RISK TO INFLATION, INFLATION EXPECTATIONS
RBA FAQs
The Reserve Bank of Australia (RBA) sets interest rates and manages monetary policy for Australia. Decisions are made by a board of governors at 11 meetings a year and ad hoc emergency meetings as required. The RBA’s primary mandate is to maintain price stability, which means an inflation rate of 2-3%, but also “..to contribute to the stability of the currency, full employment, and the economic prosperity and welfare of the Australian people.” Its main tool for achieving this is by raising or lowering interest rates. Relatively high interest rates will strengthen the Australian Dollar (AUD) and vice versa. Other RBA tools include quantitative easing and tightening.
While inflation had always traditionally been thought of as a negative factor for currencies since it lowers the value of money in general, the opposite has actually been the case in modern times with the relaxation of cross-border capital controls. Moderately higher inflation now tends to lead central banks to put up their interest rates, which in turn has the effect of attracting more capital inflows from global investors seeking a lucrative place to keep their money. This increases demand for the local currency, which in the case of Australia is the Aussie Dollar.
Macroeconomic data gauges the health of an economy and can have an impact on the value of its currency. Investors prefer to invest their capital in economies that are safe and growing rather than precarious and shrinking. Greater capital inflows increase the aggregate demand and value of the domestic currency. Classic indicators, such as GDP, Manufacturing and Services PMIs, employment, and consumer sentiment surveys can influence AUD. A strong economy may encourage the Reserve Bank of Australia to put up interest rates, also supporting AUD.
Quantitative Easing (QE) is a tool used in extreme situations when lowering interest rates is not enough to restore the flow of credit in the economy. QE is the process by which the Reserve Bank of Australia (RBA) prints Australian Dollars (AUD) for the purpose of buying assets – usually government or corporate bonds – from financial institutions, thereby providing them with much-needed liquidity. QE usually results in a weaker AUD.
Quantitative tightening (QT) is the reverse of QE. It is undertaken after QE when an economic recovery is underway and inflation starts rising. Whilst in QE the Reserve Bank of Australia (RBA) purchases government and corporate bonds from financial institutions to provide them with liquidity, in QT the RBA stops buying more assets, and stops reinvesting the principal maturing on the bonds it already holds. It would be positive (or bullish) for the Australian Dollar.
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