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Australian dollar falling may force interest rates to go higher

Australian dollar falling may force interest rates to go higher

CANBERRA: Australian dollar falling may force interest rates to an average of 2 per cent for the end of the year and the first quarter of 2016. If the fall in the dollar continued, there could be another 5 per cent rise in the price of imports in 2015 and again in 2016.

The Reserve Bank’s cash rate stands at 2.25 per cent.

The most recent Bloomberg survey of economists produced an average interest rate forecast of 2 per cent for the end of the year and the first quarter of 2016.

Of the 28 economists polled in the survey, only Mr Eslake, BT and ING tipped cash rates of more than 2 per cent in December.

Mr Eslake said the lower dollar would boost the economy by making exports more competitive but it would also lead to inflation through more expensive imports.

As a result, pressure on the Reserve Bank to further cut rates would be “significantly reduced as we move into the latter part of the year”.

Mr Eslake said the lower dollar was close to the US75¢ level that Reserve Bank governor Glenn Stevens considered appropriate.

“Indeed, the Reserve Bank’s own internal analysis as of February suggests the Australian dollar is only 2 per cent overvalued on a trade-weighted basis,” he said.

Reserve Bank modelling suggested manufacturing, mining, business services and tourism would all benefit from a lower dollar, he said.

Construction would suffer from higher costs in the short term but benefit over the medium term. The education and health sectors would suffer “negligible” effects. However, the downside of a lower dollar was inflation.

Since the Australian dollar began falling in March 2013, imports of food had risen 19 per cent in price and those of food and clothing 17 per cent, he said.

Because of the inflationary impact of the lower dollar, “the market is too aggressively pricing in [rate] cuts”, Mr Eslake said.

With stimulus from the lower oil price, the lower Australian dollar and low interest rates, “the pendulum may indeed swing back to the expectation of rate hikes later in the year”. The factors that would have to “go right” included the US Federal Reserve lifting interest rates and an “improvement of the political situation that would foster a sustainable recovery in business confidence”.

Mr Eslake’s prediction of an Australian dollar at US73¢ at the end of 2015 and US68¢ at the end of 2016 is substantially lower than most other predictions.

The average forecast from a recent Bloomberg survey is US75¢ for the end of 2015 and US77¢ for the end of 2016.