RBA Kent: AUD TWI Decline To Add Only 0.2% To CPI Level Over Few Years

--Models suggest AUD TWI depreciation will add only 0.2% to CPI level over few years
--Kent reminds TWI has greater bearing on imported inflation than bilateral trade
--Rise in US interest rates not likely to have significant effect on Aussie banks funding costs
--Size and timing of RBA rate will depend on household spending response
--Cash rate increases will also depend on outlook for inflation and labor market
--Higher USD will add some pressure on inflation in other advanced, emerging economies
--But higher US Rates will also dampen global demand, leading to price fall in USD terms
--AUD in TWI Terms has moved in line with fundamentals – commodity prices, rate differentials

By Sophia Rodrigues

(Sydney, October 24, 2022)—The trade-weighted index of the Australian dollar has a greater impact on imported inflation and the depreciation so far will add only 0.2 per cent to the level of consumer price index over the course of a few years, a senior Reserve Bank official said Monday.

The RBA assistant governor Christopher Kent made the comment in a speech at the Commonwealth Bank Global Markets Conference on the topic, “Exchange Rates and Inflationary Pressures.”

Kent noted the Australian dollar in TWI terms has depreciated around 2% over the year to date, and it is this fall that has a greater bearing on imported inflation than the decline versus the US dollar.

“A rough rule of thumb from our models suggests that the level of the Consumer Price Index (CPI) will be higher by only around 0.2 per cent in total over the course of a few years,” Kent said.

In the speech, Kent reiterated the RBA’s guidance that it expects to increase interest rates further in the period ahead. The size and timing will depend on incoming data, including the response of household spending to tightening in financial conditions that is still working its way through the system.

“Rate increases will also depend on the outlook for inflation and the labor market,” Kent said.

Kent said the depreciation of currencies against the USD will put some pressure to already high rates of inflation in a wide range of advanced and emerging economies through rise in imported inflation.

But he also pointed out that higher interest rates will dampen growth of US demand for goods and services, thereby contributing to easing in global demand. Higher USD could also lead dampen demand from households and firms in other economy as they “will not be as willing nor able to pay the same US dollar denominated prices for their imports.”

--Contact: Sophia@centralbankintel.com