In its Financial Stability Review (FSR) published on Thursday, the Reserve Bank of Australia (RBA) warned that the US “tariffs could have a chilling effect on business investment and consumer spending.”
Additional takeaways
US tariff uncertainty poses substantial headwinds to global growth.
Risk of disorderly correction in global asset prices, putting pressure on non-bank lenders.
Hedge funds particularly vulnerable to repricing of risk due to highly leveraged positions.
US tariffs on China may necessitate further policy stimulus from Beijing.
Global slowdown, particularly in China, could spill over into Australia.
Risk aversion could increase financing costs and cause liquidity strains.
Australian financial system well placed in the event of a severe global downturn.
Strong financial position of most households and banks limits the risk of widespread disruption.
Australian banks well capitalised and able to absorb large loan losses.
Important that bank lending standards remain sound and are not relaxed.
Budget pressures pervasive across Australian households, but expected to ease a little.
Wary that lower interest rates could encourage households to take on excessive debt.
Market reaction
At the time of writing, AUD/USD is losing 0.37% on the day to trade near 0.6275.
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.