The Reserve Bank of Australia's (RBA) claim that the Australian dollar is overvalued is not only wrong, it's disingenuous, according to new research by National Australia Bank.
"We're taking issue with the contention that the RBA continues to repeat that the Australian dollar remains fundamentally overvalued, in particular with relation to the weakness in commodity prices," Ray Attrill, co-head of FX Strategy at National Australia Bank (NAB), told CNBC.
In the RBA's recent monthly policy statements, the central bank frequently stated that the currency "remains above estimates of its fundamental value, given the significant declines in key commodity prices," particularly Brent crude's 40 percent decline over the past six months and a decline in iron ore prices to a six-year low. Fair value, according to RBA governor Glenn Stevens, is 75 U.S. cents – a 4 percent decrease from current levels.
The RBA claims the currency is overvalued by comparing its index of commodity prices to the trade-weighted Australian dollar (AUD TWI). In the year through January, the commodity index dropped 20 percent, while the AUD TWI only fell 5.6 percent, so the RBA insists that the currency needs to fall further to catch-up with commodity declines.
However, data compiled by NAB paints a different picture: "From the peak in the commodity price cycle (in 2011) and the peak of the AUD TWI (in 2013), both have actually fallen both by a similar amount – 20 to 25 percent," Atrill said.
Moreover, it is disingenuous to compare changes in commodity prices with changes in the currency and implicitly suggest they should equate, NAB said. It pointed to data showing Australia's terms of trade (ToT) – largely based on commodity prices given the economy's resource-abundant nature – increased by over 100 percent between 1998 and its 2011 peak, yet the trade-weighted AUD TWI appreciated by only 50 percent over that period.
To be sure, Atrill isn't bullish on the currency. Rather, he believes that further weakness can only be justified by deeper commodity price declines and additional greenback strength.
Is the RBA right to jawbone?
The central bank asserts that it talks down the currency to help the Australian economy as the country attempts to rebalance growth away from resources towards non-mining sectors.
"To be fair, the RBA were right in calling the AUD overvalued back when it was above 90 cents," said Jim Devonport, corporate client manager at Compass Global Markets. "I think they are shying away from calling it much lower, to be honest."
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Both Atrill and Devonport believe the Aussie dollar is at fair value presently, both against the U.S. dollar and in broader trade-weighted terms.
On the other hand, HSBC believes further weakness is needed to boost business confidence, a factor that it considers a key obstacle to Australia's economic recovery.
"Business confidence [among non-mining sectors] has been low. For some firms, the problem has been the high cost of doing business in Australia. The fall in the Australian dollar over recent years has helped, but an even lower currency would provide further help. The RBA still believes the AUD is overvalued and we do too," said Paul Bloxham, chief economist, Australia & New Zealand, at HSBC in a recent note.
Some analysts agree.
"Whether the currency is overvalued or not depends on a number of factors, such as investment cycles. If the Australian economy is in the middle of a retrenchment in mining investment, then arguably the currency should be trading lower," Greg Gibbs, senior currency strategist at the Royal Bank of Scotland, told CNBC.
While the medium-term outlook for the currency suggests more weakness, Gibbs believes it's possible to see a rebound back to 80 U.S. cents in the short-term.