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.