Interpac Business and Migration Solutions Melbourne Australia

(October 18, 2010)

THE Reserve Bank has been warned not to be lulled into a "trap" of believing a rising currency will lessen the need for further rate hikes.

This comes as the Australian dollar briefly broke the psychological level of parity with the greenback on Friday, The Australian reports.

Late on Friday the dollar hit parity with the US dollar - the first time since the exchange rate was floated in 1983.

Tipping it over the line were comments by US Federal Reserve chairman Ben Bernanke last week about the prospect for a second round of quantitative easing measures to stimulate the economy.

Mr Bernanke said the central bank was "prepared to provide additional accommodation if needed to support the economic recovery and to return inflation over time to levels consistent with our mandate".

Leading market economist Tim Toohey of Goldman Sachs told clients that he believed tomorrow's release of RBA board minutes would show that policymakers paused on lifting rates earlier this month because of the sharply appreciating currency.

But Mr Toohey argued that the risk that a marginal lift in official interest rates would "prompt a sharp reversal in domestic demand growth" was quite small.

Rather, the far greater fears were that improved financial conditions as a result of skyrocketing terms of trade and the rebounding stockmarket were underestimated.

"The resulting rise in investment could push economic growth well above potential, unleashing wage cost inflation and risk entrenching inflation expectations," Mr Toohey said.

Analysis by Goldman Sachs through its Financial Conditions Index shows that strong export prices and lifting equities could still add another 1.17 percentage points in GDP growth in 2011, despite its forecasts for the Australian dollar to trade at $US1.05 for six to 12 months.

"From our perspective, the dollar appreciation has not materially altered the likely path of Australian economic growth over the next 12 months," Mr Toohey said.

"Indeed, it is worth noting that empirically we find that it takes 24 months for the full impact of the dollar appreciation upon economic growth to be realised."

Many economists now believe the Australian dollar could soon hit $US1.10.

But federal Treasurer Wayne Swan yesterday cautioned that intervening to devalue the Australian dollar would be a mistake.

"Some of us remember well the last time Australia attempted to fix its currency at the same time we were experiencing a terms of trade boom in the mid-1970s," he said in his economic note.

"The result was that headline inflation rose from around 5 per cent to 17.6 per cent in a little over two years."

But not all market watchers are convinced the Aussie will move above parity and hold its gains.

In a note to clients at the weekend, Credit Suisse analysts said the Australian dollar looked overbought and vulnerable to correction. "But just because it is overvalued does not mean that a correction is imminent."

Morgan Stanley chief economist Gerard Minack said the Australian dollar was overvalued but he did not expect it to return to fair value soon.

（Source:News.com.au）