Watch The Dollar, Watch Oil

By Glenn Dyer | More Articles by Glenn Dyer

The value of the Australian dollar has emerged as the major variable for interest rates, along with the progress of oil prices for the next day or so with a major hurricane threatening the US Gulf Coast and oil producing facilities.

The dollar fell 5.1% from Friday to Friday to end at 79.77 USc in New York. It actually fell under 78 USc at one stage before it finished at 78.10 USc.

It had been around 85.05 in Sydney late last Monday, so the fall from that level was 6.1%. From its peak of around 88.71 last month it has fallen 12%.

Oil prices have retreated from the high of $US88.77 in New York last month, so the fall in the Aussie dollar has been cancelled out.

But so long as the dollar remains at current levels (which are around where the dollar was in January-February), any oil price rise will be much greater: and the most immediate factor that could drive prices higher is Hurricane Dean in the Gulf.

Given the delicateness of inflation pressures in this country at the moment, Australia doesn't need a fire lit under the $A dollar value of oil prices at the moment.

And even though other commodity prices are weaker, its rising oil prices can deliver a short sharp shock to the economy.

The US Fed cut its discount rate to convince lenders to restart lending to keep the US economy growing.

It abandoned its central focus on inflation for one of worrying that the instability might threaten growth. It hasn't cut the Federal Funds rate because it feels the wider US economy is still absorbing the panic and fear from the markets and hasn't been wounded…yet.

Local investors should keep that in mind.

Or if there is any doubt, read this quote from the Reserve Bank Governor, Glenn Stevens on the Gold Coast on Friday where he appeared before the House of Reps Standing Committee on Finance and Economics.

"Would we have increased the rate last week if we had known about this?

"Of course, you cannot really go back and remake decisions on the basis of information that was not available then. We could see that there were tensions in global markets to some extent.

"We did not think at that time that those things were likely to make a difference to the macroeconomic outlook sufficiently to outweigh what we thought was a pretty clear case for a modest adjustment to interest rates. I still think that. Most likely, the global economy has pretty strong fundamentals.

"It is true that the US is weak, but other areas of the world have been accelerating over recent times, particularly China, which is very important to Australia. I do not have any reservations about last week's decision."

That means no going back and no changes because he went on to make quite clear that he saw no reason to change the outlook for Australia.

"Australia's terms of trade have kept rising and stand at a five decade high. This has added about 1½ per cent of GDP to the annual growth rate and Australia's national income per year over the past couple of years, which is quite an expansionary force.

"It would be imprudent to assume that this trend will continue indefinitely; nonetheless, it has already gone considerably further than most observers anticipated.

"When we lift our gaze beyond the conventional forecasting horizon, the big picture is that the emergence of potentially very large economies like China and India at such a rapid pace and with such consistency is unlike anything that we have lived through before.

"We cannot be confident, therefore, that the cyclical experience of the past few decades is necessarily a reliable guide to how things will develop."

"The fact that the global economy has been so strong, that core financial institutions after years of strong profits are well capitalised, and that real sector corporate profitability in most countries is very sound, will be helpful in coping with tougher credit conditions if they persist.

"Indeed, global growth has of late been sufficiently strong that some moderating effect would be welcome.

"An adjustment to investor behaviour needed to occur, and was almost certainly overdue."

So we should understand there is not much sympathy at

Martin Placeat the moment for the type of pain being felt in financial markets (of all kinds).

This is the key to the way the RBA sees things and why the US Fed's move was so dramatic and such a big deal.

US regulators would have shared the same feeling that "some moderating effect "would be welcome", but obviously in the eyes of the Fed that had become something more threatening, rather than beneficial.

It will take months for the sub-prime mess to unravel and for some lenders and funds to go to the wall, and for the Fed and other central banks to clean up the hundreds of billions of dollars pumped into the various markets and economies to keep things afloat.

That will have to be done without sending a message that support had gone and it was everyone for themselves.

Companies, people, brokers, whatever will fail as a result. That'll keep the sharemarket edgy, but at least it's not heading for the cliff any more (we hope!)…

But the focus remains on inflation here in Australia, so no rate cut and any central bank that cuts official rates because of market turmoil will cause the very problems it is trying to avoid.

Mr Stevens also made this point on Friday:

"There is a lot of financial volatility at present, and a lot of people are very uncertain and are behaving in a way which in the past few days could be seen as bordering on irrational.

"That happens from time to time in financial markets.

"What is key for us is to come back to the fundamentals of this economy, and I think those fundamentals are strong.


About Glenn Dyer

Glenn Dyer has been a finance journalist and TV producer for more than 40 years. He has worked at Maxwell Newton Publications, Queensland Newspapers, AAP, The Australian Financial Review, The Nine Network and Crikey.

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