A strong exchange rate helps offset the inflationary impulse from the terms of trade shock, the Reserve Bank of Australia said in a paper prepared for a conference, jointly hosted by the International Monetary Fund, the Australian Treasury and the RBA in Canberra.
Domestic inflationary pressures, will lead to higher inflation for non-tradable goods and services. But at the same time, the gradual pass through of the initial exchange rate appreciation will lead to lower inflation for tradable goods and services, the paper prepared by economists, including RBA assistant governor Christopher Kent, said.
"In this way, appreciation of the exchange rate helps to offset the inflationary impulse from the terms of trade shock, and assists in maintaining inflation in line with the inflation target."
The study noted that the current forecasts suggest that the terms of trade will remain high in comparison to pre-boom levels.
The paper also noted that the strong growth in investment and employment in the resource sector are placing upward pressure on prices and wages. However, this has been offset to some extent by the appreciation of the exchange rate, which has led to a loss of competitiveness and downward pressure on prices in other industries, particularly those exposed to foreign trade, it noted.
Releasing the minutes of the September Policy Board meeting on Tuesday, RBA said the strength of the currency and slowing Chinese growth are risks to the economy.
The RBA report suggested that though Chinese investment in Australia has increased rapidly since the mid 2000s, particularly in the Australian resource sector, it still represented only 1 percent of total foreign investment in Australia at the end of 2011.
by RTT Staff Writer
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