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Dollar's new strength a headache for RBA

Former US Treasury Secretary Lawrence Summers did the Reserve Bank of Australia no favours by pulling out of the race to take over at the Federal Reserve.

The Aussie dollar climbed to a three-month high of 93.94 US cents yesterday in Sydney as investors bet the withdrawal means the US central bank, which starts a two-day meeting today, will pare stimulus at a more gradual pace. The dollar was fetching 93.2 US cents this morning.

Three-year Australian sovereign yields fell six basis points to 2.85 per cent, unwinding most of the climb since the RBA left its key borrowing cost at a record low and said the currency may weaken.

“To the extent that the Fed begins to taper and stops printing US dollars, that could support the US dollar and help the Aussie continue to fall,” said Peter Jolly, the head of market research for National Australia Bank. “The currency moving up here is definitely problematic and will in itself leave the RBA biased to cut rates.”

The dollar climbed 4.9 per cent this month, snapping a five-month slide that had matched its longest losing streak since 1998. The rally erodes the benefits from a lower currency for companies from Rio Tinto to Woodside Petroleum  and risks undermining business confidence that jumped last month to levels unseen in more than two years.


RBA governor Glenn Stevens said after the bank’s rates meeting earlier this month the currency “remains at a high level” and a possible depreciation in the exchange rate would help to rebalance growth. The RBA will release minutes today of that meeting, when he and the board left the benchmark interest rate at 2.5 per cent.

A 10 per cent currency drop boosts gross domestic product by between 0.5 percentage point and 1 percentage point over about two years, the RBA estimated August 9 in its quarterly monetary policy statement. It is possible the impact on economic activity could be slower than in previous periods if businesses wait to see if the Aussie stays at a lower level, policy makers said.

The dollar and government bonds rallied as the removal of Mr Summers from the list of potential candidates for Fed chairman buoyed higher-yielding assets. Fed vice-chairman Janet Yellen is now the front-runner for the job when Ben Bernanke’s term expires in January, according to Pimco chief executive and co-chief investment officer Mohamed El-Erian.

“Markets will likely interpret this as significantly increasing the probability of broad policy continuity at the Fed,” he wrote in a commentary on the Business Insider website.

The Federal Open Market Committee is expected to slow its monthly bond purchases to $US75 billion at the meeting starting today, from $US85 billion currently.

Rio Tinto, the world’s second-largest mining company, said last month that depreciation in currencies including those of Australia, Canada and South Africa versus the greenback boosted underlying earnings for the company in the first half of the year by $US211 million versus the comparable 2012 period.

A rebound in iron ore, Australia’s biggest export, and a surge in sentiment have curbed expectations for more rate cuts and driven a rebound in the Aussie this month.

The impact of a stronger currency on RBA policy “will depend on how much the rise in the Aussie is consistent with broader fundamentals,” said John Horner, a strategist at Deutsche Bank. “For the moment, the rise in the Aussie being associated with rising commodity prices is less of a headwind for the Australian economy.”

Interest-rate swaps data show traders see a 64 per cent chance Mr Stevens and his board will keep the cash rate unchanged by the end of 2013, up from 38 per cent odds on August 31.

Hedge funds and other large speculators last week trimmed bearish bets on the currency to the least since the period ended June 4, according to Commodity Futures Trading Commission data.

“The RBA would see it as an issue if we were to get not just further currency strength but also the Aussie staying at current levels for a sustained period of time,” said Hamish Pepper, a currency strategist at Barclays in Singapore. “I wouldn’t be surprised to see the rates market in Australia start to price a higher likelihood of further rate cuts.”