Aussie steady, buoyed by monetary policy divergence

Central banks have a key mandate which is to ensure that there is price stability in a country or region. Economies constantly experience inflation or deflation when prices for certain goods and services are fluctuating. Constantly rising prices for the same goods means inflation, constant low prices for the same goods means deflation. It is the central bank’s job to keep demand in line by changing its policy rate. For the largest central banks such as the US Federal Reserve (Fed), the European Central Bank (ECB) or the Bank of England (BoE), the mandate is to keep inflation close to 2%.

A central bank has an important tool at its disposal to raise or lower inflation, namely by adjusting its policy reference rate, commonly known as the interest rate. At pre-announced times, the central bank will issue a statement with its policy rate and provide additional reasoning as to why it either remains or changes (reduces or raises) it. Local banks will adjust their savings and lending rates accordingly, which in turn will make it either harder or easier for people to earn from their savings or for businesses to get loans and invest in their businesses. When the central bank raises interest rates substantially, it is called monetary tightening. When it lowers its policy rate, it is called monetary easing.

A central bank is often politically independent. Members of the central bank’s policy board go through a series of panels and hearings before being appointed to a seat on the policy board. Each member of that board often has a particular belief about how the central bank should control inflation and subsequent monetary policy. Members who want very loose monetary policy with low rates and cheap loans to stimulate the economy substantially, content to see inflation slightly above 2%, are called “doves”. Members who would rather see higher rates to reward savings and want to keep inflation under control at all times are called “hawks” and will not rest until inflation is at or below 2%.

Normally, there is a chairman or chairperson who chairs each meeting, must create consensus among the hawks or doves, and has the final say when a split vote is reached to avoid a 50-50 tie in what regarding the policy should be adjusted. The president will give speeches that can often be watched live, communicating the current monetary position and outlook. A central bank will try to develop its monetary policy without triggering violent changes in its rates, stocks or currency. All central bank members will channel their stance to markets ahead of a policy meeting event. A few days before a policy meeting takes place until the new policy has been communicated, members are prohibited from speaking publicly. This is called the blackout period.