The West

RBA finds currency battle tough

The mighty Aussie dollar was floated 30 years ago as part of the new free-market orthodoxy that swept through the developed world. But now the Reserve Bank thinks free markets have gone too far.

Unfortunately, the currency genie is out of the bottle. It's not going back and it is getting ever more difficult to control.

In the 80s global central banks used heavy handed tactics to smack currencies around, adding a healthy dose of risk to daily trading. They would call market-maker bank trading desks and dump or buy hundreds of millions of US dollars against their home currencies in less than a minute sparking moves of 2 or 3 per cent - even in highly liquid currency pairs such as the US dollar-Deutsche mark and US dollar-Japanese yen.

That changed in 1992 when billionaire George Soros famously took on the Bank of England with a £10 billion bet and won £1 billion after the British pound was ejected from the European exchange rate mechanism.

Ever since, traders and hedge funds, and the speculators, have become more emboldened, doubling up on long-term views and enforcing strong trends after each intervention.

Now the influence of central banks has waned so much the Reserve is left bleating about the "uncomfortably high" Aussie while cutting interest rates in the hope it will deter yield-seeking foreign investors.

It's been five years since the GFC, but the Aussie's gyrations still represent the settling dust from the crisis.

Instead of fighting markets, central banks have been fighting to devalue their currencies with record low interest rates. The Reserve Bank was the biggest loser in the currency war with the US Federal Reserve.

Offering some relief, last month the Fed eased its choke-hold on the Aussie economy by tapering its bond purchasing program.

It took three years, during which Australian consumers spent up on offshore on holidays or online while non-mining exporters were pushed to the edge of extinction.

While the rest of the world struggled, Australians enjoyed themselves. However, the slowdown from the high Aussie is the payback for the prosperity that wasn't used productively.

Politicians and economists told us manufacturers should simply adapt, but this gave foreign speculators free rein to milk every last drop of profit the commodity boom.

The Aussie has slowly retreated 20 per cent since its peak of $US1.1080 in July 2011, but the economy has been debilitated.

"A lack of life outside the mining sector, is expected to keep economic growth below-trend until 2015, and at the same time a lack of wage growth is expected to keep inflation contained," says currency strategist Chris Tedder. "The RBA may be inclined to cut interest rates again."

But Pimco analysts say it takes two years for currency adjustments to filter through, so it's likely to be a tough period.

Reserve Bank governor Glenn Stevens said last month he considered US85¢ reasonable for the dollar. There remains the risk of a swing to US80¢ and it could go much lower.

"I think a big part of the weakness we have seen in the dollar and several Asian currencies in recent months is the market fearing this effective tightening in financial conditions in China," Royal Bank of Scotland currency strategist Greg Gibbs said. "It threatens the growth outlook of the behemoth that has driven growth in the region and globally over the last decade."

For now offshore bulk commodity demand remains solid. But if the fickle free-market beasts sniff domestic growth weakness forcing another rate cut, there could be a big sell-off forcing a 180-degree swing by the Reserve to support the Aussie.

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