The rise of our trade-weighted currency has, in turn, been heavily influenced by RBA policy: the RBA has deliberately kept interest rates high in order to wrench overall inflation back into its target band, and it has not intervened against the currency's rise. More specifically, the RBA has relentlessly outlined the benefits of a high currency, and how the appreciating currency is the key medium through which Australia can have a resources boom without high inflation for the first time in its recorded history. Now think about the consequences of reversing that logic, as Paul Howes and other doves would have us do.
If you compare inflation in "domestic" goods and services (called "non-tradeables") with inflation in so-called "tradeables", which are those goods and services that the ABS defines as having their prices determined in global markets, you will see that almost all of the reduction in Australian inflation is being accounted for by these global consumer prices (refer to the blue line in the chart below). In contrast, inflation in non-tradeables (ie, domestic items) remains both way above the RBA's 2-3% per annum target, and in line with its average rate since December 2001.
This is where the debate about Australian interest rates and inflation becomes so incredibly silly and circular. All those arguing for much lower interest rates, and a much lower currency, are, by definition, rooting for higher tradeables inflation. A big fall in the currency will reverse out a lot of the deflationary benefits you can see in the blue, tradeables line slumping in the chart below. And without that tradeables deflation we would likely have an overall inflation challenge. This problem is accentuated by the fact that the reason "tradeables" inflation was low during much of the 2000s was because our key trading partners were flooding global markets with cheap goods--effectively exporting deflation. This is no longer happening. As the RBA has noted (and I have argued about for years here), China is now a source of inflation for Australia rather than disinflation.
