The RBA and Foreign Exchange Market Intervention

Last week, Reserve Bank of Australia (RBA) Governor Glenn Stevens announced that despite the Australian Dollar being "somewhat overvalued", the RBA does not plan to intervene in the foreign exchange market. Stevens said that, "you need to be pretty confident that it is seriously over-valued, or the market is behaving in some quite irrational way, before you would launch large-scale intervention."

But why exactly would the RBA want to intervene? We will discuss that in the following paragraphs.

In the past, the Australian Dollar was pegged to the UK pound and then later on to the US Dollar. However, this exposed the currency to external shocks, such as shifts in terms of trade. Severe shocks then resulted in significant inflation or deflation in the local economy.

The government, thus, had to find a way to curb the effects of a shock, which they did through intervention. When the Reserve Bank intervenes, they buy or sell Australian Dollars, vs. common cross currencies such as the GPB and USD, to create demand or supply for it. The RBA will usually do so by entering into the foreign exchange market in its own name in a public statement. Such intervention also sends a signal to the market on RBA price targets. In simple terms, intervention is done in order to prevent significant changes in the market from severely impacting Australian trade and economy. The RBA selling AUD into the market will help the Australian export industry at the expense of importers.

However, the RBA has increasingly minimised its intervention in the market since shifting to a floating exchange rate in the early 1980s, Today, it only chooses to intervene in extraordinary situations. During the 2007/2008 global economic crisis, for example, the RBA had to intervene several times to improve liquidity and curb severe price movements in the market. We would be cautious about punting on the Australian dollar going up vs popular cross currencies because if the RBA do choose to intervene you don’t want to be on the wrong side of that trade given the magnitude of their market entry in past interventions.