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Does the falling Australian dollar influence interest rates?

Team Veye | 13 Dec 2021

Does the falling Australian dollar influence interest rates?

The Reserve Bank of Australia kept the cash rate unchanged at a record low of 0.1% for the 13th month in a row during its last meeting of 2021, saying inflation had picked up but remained low in underlying terms.

Policymakers were of the view that inflation pressures are less compared to many other countries, amid modest wages growth. The board restated that it will not increase the cash rate until Australia's actual inflation was sustainably within the 2% to 3% target range.

Earlier, Reserve bank governor had told a meeting of economists that Australia remained well-placed to bear inflationary pressures triggered by the Covid pandemic without resorting to an early raising of the cash rate.

The cash rate is determined by the Reserve Bank of Australia every month (excluding January). This rate is the rate charged on loans between financial institutions (like banks), and it has a significant impact on the price of financial products.

The committee said that it will continue to buy government bonds at a pace of $4 billion a week until February, when it will review the operation. By mid-February, the RBA will hold a total of $350 billion of the bonds.

Since there is strong rebound in activity and the pick-up in inflation, economists expect the Bank to taper its bond purchases to $3 billion in February and to end them completely in August.

The Reserve Bank of Australia (RBA) also decides on where to set the benchmark interest rate. As short term interest rates are an important determinant of currency valuation.

Falling dollar adds to already existing inflationary pressure. And higher the level of inflation, the more likely it is that the Reserve Bank will bring forward its first increase in the cash rate.

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