Will the Reserve Bank of Australia (RBA) base the remainder of policy decisions in 2015 on the cost of housing or the desire to pursue a lower exchange rate? The choice will likely determine the ultimate direction of the AUD for the remainder of the year.

As far as currency markets go, two key issues were picked up by traders following the June RBA policy decision on the 2nd of June: the level of the Australian dollar exchange rate complex and house price rises, particularly in Sydney.

The Australian dollar rallied across the board following the decision confirming to us that currency markets took the view that no further cuts to the Australian interest rate is likely in the near-term. The Bank has cut rates twice already this year and speculation continues as to whether another AUD-negative cut may be delivered.

Central bank policy on interest rates remains the single most important determinant of exchange rates at the current time. The Aussie has traded at historically high levels in recent years owing to the high level of Australian interest rates relative to other nations since the 2008 financial crisis.

And this has increasingly become a headache to the RBA over the course of the past 12 months.

RBA says the Australian Dollar Still too High

The biggest indication that another 2015 rate cut could occur came in the statement that accompanied the decision. The RBA communicated:

“The Australian dollar has declined noticeably against a rising US dollar over the past year, though less so against a basket of currencies. Further depreciation seems both likely and necessary, particularly given the significant declines in key commodity prices.”

So while the Aussie dollar may have made some progress against the Greenback, declines against a host of other major currencies are deemed to be inadequate. The Australian economy needs a cheaper currency if global demand for Australian goods is ever to increase substantially.

Those with the levers to the economy are desperate for economic growth to take up the slack that the declining mining sector is leaving in its wake. Controlling the exchange rate via cutting interest rates is one trigger that could be pulled at the RBA.

But – Housing Prices are a Worry

The problem cutting interest rates presents is that it can fuel inflation, particularly in the housing sector where low credit costs encourage increased activity.

“Stronger lending to businesses and growth in lending to the housing market broadly steady over recent months. Dwelling prices continue to rise strongly in Sydney,” note the Bank.

Ipek Ozkardeskaya at London Capital Group says reflects that the communication has been sufficient for markets to price out another interest rate cut:

“The historically low rates drive capital toward the housing market, which is not bad news per se given the efforts to shift labour from mining to the housing sector. However, the RBA should be cautious of a potential low-rate-induced real estate bubble and avoid any accident in this structural transformation.

“Expectations for an RBA rate cut over the next twelve months faded below 25 basis points, practically signalling less probability for lower than 2% bank rate in Australia.”

It is this fall in expectations that is aiding the Aussie dollar higher.

For the RBA the question then becomes - will the exchange rate take preference over housing, or is a house price bubble simply too risky?

We have a hunch the RBA may lean on mechanisms other than interest rates to cap house prices, allowing more space to cut rates and force the Australian dollar exchange rate complex lower.

The RBA itself suggested that non-interest rate settings may be utilised: “the Bank is working with other regulators to assess and contain risks that may arise from the housing market. In other asset markets, prices for equities and commercial property have been supported by lower long-term interest rates.”

Utilising other tools to combat house prices leaves the RBA free to chase the exchange rate lower and leaves markets over-pricing the AUD, look for a correction lower.

That said, any moves here would be over a relatively long time frame. The Bank does not appear to be overly concerned about the current level of the AUD at this point, as such we would watch for signs of increased agitation on the matter in coming months ahead of any further interest rate cut.