The Reserve Bank of Australia: A Trader’s Guide

The Reserve Bank of Australia (RBA) is one of the world’s most important Central Banks and by its actions controls the path of the Australian Dollar. The Central Bank performs an important role in defining banking practices and works closely with other International Central Banks. So, let’s take a look at who runs the RBA and how they control monetary policy.

The Reserve Bank of Australia can trace its origins back to the formation of the Commonwealth Bank of Australia in 1911. Over time it acquired more and more responsibilities of a central bank with its powers formalized at the end of the second world war through the Commonwealth Bank Act 1945 and the Banking Act 1945. As the organization’s central banking activities grew it reached a stage where it required the formation of a separate body, resulting in the Reserve Bank Act 1959. The Reserve Bank of Australia (RBA) was thus created and began operations on 14 January 1960.

Who Owns The RBA?

The Central Bank is a body corporate wholly owned by the Commonwealth of Australia unlike many other Central Banks globally that still have private shareholdings such as the Bank of Japan, the South African Reserve Bank, and the Swiss National Bank. The US Federal Reserve on the other hand has been described as both a public and private institution. Federal Reserve Banks are set up like private corporations where member banks hold stock in the Federal Reserve Banks and earn dividends.

WHO IS ON THE BOARD OF THE RESERVE BANK OF AUSTRALIA (RBA) AND HOW ARE THEY APPOINTED?

The board of the RBA consists of nine members and includes the Governor, Deputy Governor, and the Secretary to the Treasury. There are six non-executive members who are then appointed by the Treasurer for terms up to five years with no restriction on the number of terms a member may serve. The Governor and Deputy Governor on the other hand are appointed for terms of up to seven years and are eligible for reappointment.

The RBA Governor is required by the Reserve Bank Act 1959 to keep in contact with the Treasury Secretary on matters relating to the Treasury and the Reserve Bank. The Governor and other senior members of the RBA have appeared twice annually before the House of Representatives Standing Committee on Economicsto explain the conduct of the bank, a process started in 1996.

ROLES AND RESPONSIBILITIES OF THE RESERVE BANK OF AUSTRALIA?

The RBA serves as the nation’s banknote issuing authority with its primary role being to ensure that monetary and banking policy is used to help the Australian people.

The key mandates of the RBA are set out as follows:

  • The stability of the currency of Australia.
  • The maintenance of full employment in Australia, which is considered to be between 5-6% unemployment.
  • The economic prosperity and welfare of the people of Australia.

There have been a lot of changes to the RBA since the 1980s with the overall mandate remaining constant. The bank adopted a policy of inflation targeting in the early 1990s with the aim of maintaining an annual inflation rate between 2-3% on average. The targeted inflation range was first set in 1993 and was then formalized in 1996 by then incoming Governor Ian Mcfarlane. Should inflation go above the 2-3% target, the Reserve Bank of Australia may increase interest rates. The increase in interest rates should in theory result in an appreciation of the Australian Dollar as capital flows are likely to increase due to a higher yield.

AUD/USD 15 Min Chart Indicating the Immediate Impact of a 25bps Interest Rate Hike

**Note: The chart above shows the immediate reaction of a 25bps hike on June 6, 2023The pair has gained over 150 pips since in a week since the announcement.

THE EFFECT OF INTEREST RATES AND MONETARY POLICY ON THE AUSTRALIAN DOLLAR

The RBA uses monetary policy in the form of interest rate hikes or cuts to ensure the stability of the currency and target inflation. An increase in interest rates usually results in less currency in circulation which in turn will increase demand and thus lead to an appreciation of the currency, while an interest rate cut has the opposite effect. The lowering or ‘cutting’ of interest rates makes borrowing more attractive and results in more money in circulation. The increased supply leads to a depreciation of the currency while encouraging investment into the economy as citizens seek a better return than the low interest rate environment provides.

It is important for traders to note that an increase or decrease in expectations may also have this effect. To give an example, if the RBA keeps interest rates unchanged but issues forward guidance (tells the market) that they expect more interest rate hikes in the future, the value of the Australian Dollar will appreciate. This is the general principle and norm, however, there are occasions and instances when markets react differently, and this is what makes and keeps the markets interesting for many of us.

The table below displays the possible scenarios that come from a change in interest rate expectations. Traders can use this information to forecast if the currency is likely to appreciate or depreciate and how to trade it.

TOP TAKEAWAYS FROM THE RBA

  • The RBA was created and began operations on 14 January 1960.
  • The RBA is wholly owned by the State with no private shareholders.
  • The key mandates of the RBA are the stability of the currency of Australia, maintenance of full employment in Australia (considered to be between 5-6% unemployment), and the economic prosperity and welfare of the people of Australia.
  • The main tools used by the RBA to achieve its mandates are changes to the interest rate as well as quantitative easing and tightening.

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