RBA interest rate decision takes some pressure off the exchange rate

The cut has been welcomed by many observers, and it is warranted given the current risk levels in the Australian economy. It does seem to be the right decision because inflation is declining and the dollar is overvalued. In recent years the RBA has seemed to be overly concerned with inflation, and not the high level of the dollar.

This has put significant pressure on a number of sectors of the economy in an environment where macroeconomic risk in Australia is high due to weak economic conditions overseas and an overvalued domestic housing market.

This should reduce the cost of borrowing and help take some pressure off the exchange rate. That in turn may have the effect of giving a boost to sectors such as manufacturing, retail, tourism and education. It could also mean the housing market can pick up steam again.

The RBA says on the back of international financial developments, the growth outlook for next year looks a little weaker, while inflation was expected to be consistent with the target, and over the coming one to two years the Bank expects inflation to be in the 2–3 per cent range.

Cutting rates could be the key to helping Australia navigate the turbulence of the global economy. Australian inflation is not high by current international comparisons and does not pose as much of a threat to our economy as record highs for the currency.

Given two ‘evils’ – inflation or an appreciating currency – it is clear that our current level of inflation is by far the lesser evil of the two. Officially amending the inflation target to be in the 2-4 per cent range could prompt some easing in the value of the Australian Dollar, down from what are still historically high levels.

Dr Jonathan Reeves is a financial economist at the Australian School of Business.