Transcript of Question & Answer Session The Extraordinary Decline in Australia's Net Foreign Liabilities

Penny, thank you so much. That was quite fascinating. We have a few questions coming in that I’ve been monitoring. I think the first one I’ll take is: you mention that the exchange rate is continuing to act as a shock absorber but, even though the RBA has been raising interest rates, the exchange rate has depreciated. What’s going on?

Well, it’s a good question and it’s an important one. So, all else equal, a rise in domestic interest rates in Australia are relative to interest rates offshore increases the demand for Australian-dollar assets, or Australian assets, and increases the value of the Australian dollar. But, of course, we’re not in an ‘all else equal’ world. Other central banks are raising rates and for the same reasons: to combat high inflation. So, despite raising interest rates since May 2022, the Australian dollar has depreciated by three per cent in trade-weighted terms and about nine per cent against the US dollar; maybe it’s a bit closer to 10, actually. There have been other global developments in the ‘not all else equal’ front. There have been concerns about growth in China and developments there. Australia is, of course, a major exporter of commodities, and China is our largest trading partner, so raising interest rates has helped to support the currency. The dollar would have been much lower than otherwise, if we hadn’t done that, so it is still working, I would say. The other point I would make is that which exchange rate you use actually really matters. If you’re talking about what’s the effect, say, on imported inflation, it’s the trade-weighted index. And, as I mentioned, that has depreciated but only by about three per cent since May 2022, whereas it’s really the US dollar where there’s been the bigger depreciation. And that has mostly reflected US-dollar strength, given what’s been going on there, and that actually has the effect of raising the value of our superannuation assets.

That’s positive. Speaking of the US, there’s another question, noting that US Treasury yields have increased a lot over the past month, and some speakers from the Fed have said that it’s doing some of the work for the Fed. We’ve seen yields in Australia go up as well. How does the RBA think about that?

Well, it’s obviously something that we, along with financial markets, are watching extremely closely, along with other central banks as well. And I think the way to think about the rise in yields: you can kind of decompose long-term yields into two elements, as most people in this room will know, you can look at the real yield and then there’s expected inflation. Now, inflation expectations are still pretty-well anchored in advanced economies around, not too far from targets between two and three per cent, and most of the rise has really been in real yields and that reflects a range of factors. But more recently there’s a few different things at play. Most of them, perhaps some of them, and I am talking very recently, do reflect term premier, whereas earlier it was the central bank raising policy rates and policy rate expectations. So, yes, term premier has risen a bit, and that reflects uncertainty about the outlook for inflation and uncertainty about the outlook for growth. And in the US in particular, where yields have been particularly volatile, it may also reflect increased issuance, given a different fiscal position and also the Feds letting their portfolio of bonds kind of roll off, as they do kind of passive QT. Some of these factors are at play in Australia, but one thing that isn’t is the general debt-and-deficits issue that’s kind of at work in the US. The other thing I’d say is that the long end of the yield curve matters a bit less in Australia. It’s not that it doesn’t matter at all; it just matters a bit less, and most of the funding here is at the shorter end of the curve. So these sorts of moves have kind of less of an implication for us than maybe they do for the Fed, where kind of long-term rates matter a bit more.

Thank you. You mentioned in your speech, Penny, that Australian banks account for a large proportion of Australia’s liabilities but how exactly is it hedged so that they aren’t left with exchange rate risk?

Yes, okay. So that’s a good question and it’s actually an important one because it also goes to the heart of this question about why, now, a foreign liability position is sustainable. So about 90 per cent of the bank’s long-term assets are hedged with derivatives, and that’s FX swaps and cross-currency basis swaps. And most of these instruments are maturity matched to the underlying debt, so they don’t only protect against kind of FX risk but also kind of rollover risk, so there’s that extra layer of protection for banks built in there.

We have been used to higher local cash rates over the last 40 years in Australia, relative to the US and Europe, to attract capital and maintain the capital current account balance. Should we consider the change in the current account will reverse this.

Look, there’s really only one country in the world, maybe there are more, but the main one is the United States where the returns on their assets are higher than the returns on their liabilities, and this has been called the US’s ‘exhibitive privilege’ in a way because they’re a reserve currency, and I don’t think that is really going to change, to be honest. Australia, we definitely have an internationalised currency, and that gives us some advantages and, in some ways, we’re a little bit like the US because we have a net foreign equity position these days. But, yes, I don’t think that relationship with the kind of rates in the US is going to change any time soon.