RBA likely concerned by relative currency strength

The RBA board minutes are due on Tuesday, and they are expected to show that the board has been encouraged by signs of stronger activity, as well as more evidence that the latest round of macroprudential measures is cooling the housing market. 

The more interesting development since the board meeting is the increased tension between improving local data and fresh large falls in commodity prices. The improvement in the local economy will keep the RBA sidelined on rates, but believe it will be frustrated by the strength of the exchange rate given that it has taken so long for the currency to catch up with earlier steep declines in commodity prices.

With the terms of trade the main influence on fair value in the RBA's model of the real exchange rate, the currency was broadly in line with fair value in Q3 before diverging by 4% in Q4-to-date as bulk commodity prices have slumped. If commodity prices hold at current levels, the model points to the exchange rate being about 6% overvalued by the start of next year, which is almost a one standard deviation divergence.

"We think that the RBA might toughen its language on the exchange rate, particularly if it does not react much to a looming Fed rate increase. We see scope for the RBA to do this in the pre-Christmas interview the governor normally does with the Australian Financial Review. In past interviews, the governor has given his take on fair value for the exchange rate, and we think it likely that he would take the opportunity to welcome a fall to the mid-60s against the US dollar", says Barclays.