RBA FSR: Risks include a pullback in elevated asset prices and stress in sovereign debt markets
In its semi-annual Financial Stability Review (FSR) published on Thursday, the Reserve Bank of Australia (RBA) warned about “risks including a pullback in elevated asset prices and stress in sovereign debt markets.”
Additional takeaways
Domestic financial system resilient, major risks offshore.
Highly leveraged trades and growth of the non-bank sector make markets more vulnerable.
Weakness in China’s property sector has pressured banks there and is likely to persist.
Australian financial system well placed to weather market shocks and a global downturn.
Banks are well capitalised, profitable, and hold significant liquid reserves.
Banks can withstand large losses given the high quantity and quality of capital.
Banks must maintain strong lending standards; non-bank lenders under close watch.
Banks should strengthen operational resilience to cyber and geopolitical risks.
Cash-flow pressures on households have eased with lower rates and inflation.
Most households are keeping up with mortgage payments and have liquidity and equity buffers.
Business insolvencies concentrated in construction, hospitality, and retail.
Supports steady macroprudential policy to contain risks in the housing market.
Superannuation funds’ FX hedging needs will grow and require careful management.
Market reaction
AUD/USD is slowing advancing above 0.6600 in Thursday’s trading so far, up 0.06% on the day.
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.
Author
Dhwani Mehta
FXStreet
Residing in Mumbai (India), Dhwani is a Senior Analyst and Manager of the Asian session at FXStreet. She has over 10 years of experience in analyzing and covering the global financial markets, with specialization in Forex and commodities markets.
