The question remains, is it realistic to expect the RBA to conduct large a scale intervention with the sole aim of influencing the exchange rate? Firstly it should be noted, the Reserve Bank is a regular participant in the foreign exchange market on behalf of the Australian Government, but according to the RBA this is “expressly designed to avoid influencing broader market conditions.” In a bulletin published last year, the RBA explained how intervention practices have evolved since the Australian dollar floated in 1983. Initially, smaller and frequent transactions were made to combat volatility, a process known as ‘testing and smoothing.’ As the number of participants grew, the need for testing and smoothing price action became less, making way for larger, less frequent intervention, where the exchange rate “overshot the level implied by economic fundamentals and/or when speculative forces appeared to have been dominating the market.” To “overshoot” based on economic fundamentals and speculative forces is clearly open to interpretation, but this at the very least this implies the RBA will avoid intervention unless deemed imperative.
The bank also noted intervention is used to combat “periods of market dysfunction” which implies periods of extreme volatility caused by both natural or market based adversity, such as the early days of the financial crises. The last time the RBA intervened was in the wake of the Lehman’s fall in 2008, which saw extreme levels of volatility and highly illiquid conditions. The Australian dollar slid to a 5-year low against the greenback and post-war lows against the Yen; prompting the bank to step-in and provide liquidity. This demonstrates the type of “market dysfunction” reserved for exchange rate intervention. More importantly, at the time the Reserve Bank explained the intervention was required to “provide more liquidity into a illiquid market,” not a direct attempt to influence the overall rate of exchange.
More recently, commentary from the central bank explained significant demand for the Australian dollar is a by-product of Australia’s resource boom and high terms of trade, while encouraging affected industry to focus on ways of boosting productivity. This of course is a nice way of saying, ‘adapt or risk being squeezed out of the market.’ Yet another tick in the ‘no RBA intervention’ box. Nevertheless, as noted in yesterday’s policy statement, the Australian dollar has remained resilient despite a marked decline in the terms of trade and weaker global growth outlook. Does this represent the type of “market dysfunction” required to intervene? Unlikely.
It’s also worth exploring the significant pitfalls associated with central bank intervention, with both Japan and Switzerland choosing to fight the battle by selling respective currencies to protect their export contingent economies. The Swiss have taken it one step further by introducing a lower-most limit or peg to the Euro of SFr1.20. The cost of waging the war against vast safe-haven flows to the region have seen their currency reserves balloon out to SFr406.5 billion in July from SFr365 billion in the second quarter. In order to mitigate the risk, the SNB will then exchange their mountain of Euro’s for other currencies. As a currency tied to a fundamentally sound economy, the Australian dollar remains a prime beneficiary of these Swiss capital flows as they translate their Euro exposure to higher ground.
In essence, unlike the monetary authorities of Switzerland and Japan, history suggests we’re unlikely to see the bank use its clout for the sole purpose of influencing exchange rates. While we can ‘never say never,’ higher rates of exchange have in the past failed to prompt the RBA to engage in currency intervention and are unlikely to do so in the foreseeable future.
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