Will a soaring Australian dollar force the RBA to cut interest rates in 2016?

The Reserve Bank of Australia remained firm when it met on Tuesday last week, electing to keep interest rates on hold for another month, but a surging Australian dollar could force its hand in the near future.

Indeed, the central bank has spent plenty of energy jawboning the Australian currency lower in recent times to try and get the dollar below the US 75 cent mark after it spent a couple of years trading above parity with the US greenback. It finally achieved its goal, and then some, with the dollar falling to a low of just US 68.28 cents in January this year.

In addition to falling Australian interest rates, the currency was also dragged down for a number of other reasons. To begin with, plunging commodity prices were dampening Australia’s growth prospects while there was also the expectation that the US Federal Reserve would hike interest rates, thus attracting foreign capital to US shores and away from Australia.

Despite the RBA’s best efforts the Australian dollar is currently sitting near its highest level in seven months at US 74.16 cents (8.6% higher than when it bottomed out), driven by rebounding commodity prices and better-than-expected GDP figures for the fourth quarter, as reported by the Australian Bureau of Statistics.

What does this mean?

Although it’s not ideal for international travellers or importers of goods and services, a weaker dollar is great for the local economy as it makes our products more competitive compared to those of international rivals.

This is particularly important in the non-mining sector. The RBA has noted an improvement here in recent months, and will not want to see that trend reversed.

As such, it’s possible that the RBA will need to re-explore the possibility of further interest rate cuts below their current level of just 2%. As noted by The Australian Financial Review, RBA board member John Edwards has recently said he would like the currency to trade around US 65 cents, representing a decline of around 12% from today’s level.

Foolish takeaway

The Reserve Bank hasn’t been too vocal about the Australian dollar when making its recent interest rate decisions, but it could certainly be on the agenda in upcoming meetings.

Given the recent rebound in the dollar, those investors who think the currency will fall again could look at buying shares of businesses such as Westfield Corp Ltd (ASX: WFD) and Cochlear Limited (ASX: COH). Both companies generate a lot of their earnings (or in Westfield’s case, all of its earnings) overseas, so a weaker Australian dollar boosts their earnings in AUD-terms.

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Motley Fool contributor Ryan Newman has no position in any stocks mentioned. Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. You can follow Ryan on Twitter @ASXvalueinvest.

The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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