On 14th February this year, Yours Truly wrote that Australian interest rates will be aligned with the rest of the Western world in the course of 2012. And that Indians might regret paying high to buy Australian dollars to watch the Indian cricket team receiving a drubbing last winter (“Dilemmas down under"). Bare Talk is pleased to update that piece.

On 2nd October, the Reserve Bank of Australia (RBA) cut the policy rate to 3.25% from 3.5%. The consensus was against a rate cut. Key explanations (verbatim quotes from RBA press release) offered for the rate cut include the following:

•Growth in China has also slowed, and uncertainty about near-term prospects is greater than it was some months ago.

•Looking ahead, the peak in resource investment is likely to occur next year, and may be at a lower level than earlier expected.

•Credit growth has softened of late and the exchange rate has remained higher than might have been expected, given the observed decline in export prices and the weaker global outlook.

Incremental changes in its thinking from the September meeting are with reference to the peak in the resource investment cycle (lower level) and higher uncertainty surrounding China’s near-term prospects. Both are related, of course. This should not have been a surprise for RBA. Many external observers, us included, have been writing about it. We were surprised by RBA’s previous “head in the sand" attitude. That was evident in the press release that followed after the August monetary policy meeting:

China’s growth has moderated to a more sustainable pace, but does not appear to be slowing further.

On 3rd October, the Australian Bureau of Statistics released trade figures for August. The trade data vindicated the rate cut. The deterioration in the trade balance has been remarkably steep and rapid. The trade deficit for August was over A$2.0 billion. The consensus forecast was for a deficit slightly under A$700 million. The deficit for July was revised up from A$556 million to A$1.53 billion. Merchandise exports declined for the third month in a row. In particular, exports to China at A$5.9 billion in August were significantly lower than A$7.2 billion in May. If one excluded the Chinese New year induced slowdown in exports to China, exports to China have not been this low since July 2011. Interestingly, exports to Japan went up during the same period.

As China’s economic hard landing becomes more evident, Australian net exports, overall economic growth and income growth for Australian households will be hit hard. Consequently, it should surprise no one if Australia joins the “zero interest rate" club in the next 12 months.

Given the remarkable deterioration in the trade balance, it is inevitable that there be a subtle shift in the thinking of the central bank on the exchange rate. From anticipating an automatic waning of “earlier exchange rate appreciation", it appears that the central bank is now explicitly concerned about the strength of the Australian dollar. To be fair, that concern was flagged to the public at the end of the September monetary policy meeting. RBA is now willing to respond to industry concerns on the overvalued Australian dollar. The rate cut signals that.

Australia is joining other countries such as Switzerland, Brazil, among others, in resisting currency strength. It has not become an explicit policy goal yet, but the shift is in that direction. That is the key message from the surprise RBA rate cut on 2 October. In that sense, the rate move by RBA is an affirmation of the shrinking pool of safe-haven currencies. At the margin, this is positive for the yellow metal.

One Australian dollar fetched 1.0625 US dollars in mid-September (only slightly weaker than the level in February this year) after the US Federal Reserve and the European Central Bank announced their asset purchase/money printing orgies. Now, the exchange rate is US$1.016/A$1. More weakness is in store in coming months. One Australian commentator recently wrote:

The Aussie’s strength is related to global market sentiment—sure the high level of Australian interest rates has been important, sure the mining boom has been important, sure central bank buying has been important, but it is all about the globe’s attitude to risk and the performance of the bellwether of global risk—the S&P 500.

We share this view of the Australian dollar. More than anything else, it is a global barometer of risk. Complacency on risk is both high and unsustainable. So is the Australian dollar. If our expectations of a decline in its fortunes are correct, it might well be worth investors taking out insurance against a fall in the S&P 500, too. In any case, Bare Talk is personally comfortable holding a short position on the Australian dollar and is content to extend such a position on any transient strength in the currency in the near term.

V. Anantha Nageswaran is the co-founder of Aavishkaar Venture Fund and Takshashila Institution.

To read V. Anantha Nageswaran’s previous columns, go to www.livemint.com/baretalk