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Australia interest rate: Can AUD find relief from hawkish central bank?

14:09, 4 July 2022

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    0.69132 USD
    -0.00226 -0.330%

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AUD traders will be looking to Tuesday’s Reserve Bank of Australia rate decision – Photo: Laura Reid/Getty Images

Traders of the Australian dollar (AUD) will be looking to the Reserve Bank of Australia (RBA) as it announces its latest decision on interest rates Tuesday, with a hike widely expected. 

Markets have priced in a rise from the current 0.85% to 1.35%, to be announced in the 5 July meeting, following hawkish comments from RBA governor Philip Lowe and recent economic data. 

This has shown strength in consumption and labour markets, but inflation rising to 5.1% – with Lowe forecasting an increase to 7% before the end of the year – boosting the case for higher rates. 

What does all this mean for the Aussie, which was up slightly against the dollar Monday above 0.68 after falling to a more than two-year low of 0.67 late last week? 

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Tuesday reaction

In the short term, said Yohay Elam, senior analyst at FXStreet, “Anything less than guidance for another 50 bps hike in August after an increase of 50 bps now would weigh on the Aussie.” 

“Upbeat employment figures and indications of ongoing high inflation have caused investors to upgrade their expectations for the central bank,” Elam told Capital.com. 

Australia's unemployment rate remained at a 48-year low of 3.9% in May and job vacancies have continued to rise. 

The RBA raised rates by 50 basis points in June, higher than priced in by the market, as RBA governor Lowe noted inflation was coming in “higher than earlier expected,” though remained lower than in most advanced economies. 

“A double-dose rate hike now is fully priced in. Without Fed-style determination to do what is needed to bring prices down, the Aussie – already vulnerable to mixed economic news from China – is vulnerable to falls,” said Elam. 

Bumpy ride

The Aussie’s recent decline has come despite the ongoing surge in commodity prices, a market move usually favourable to so-called commodity currencies. 

However, it has lost steam against the dollar – which has gained amid global market volatility as investors seek safe havens and in response to Federal Reserve rate rises – and because of its risk sensitivity. 

It has therefore suffered from downgrades in the global economic outlook this year, and as US stock markets have been through their worst first-half in 50 years. 

Its vulnerability to China's economy has also weighed on it as China has seen ongoing Covid disruption, weaker consumer sentiment, production and supply chain issues and forecasts of slower growth. 

Rate expectations

Marcel Thieliant, senior Australia and New Zealand economist at Capital economics, said in a note sent to Capital.com that the RBA was likely to lift rates by 50 basis points in July and August followed by a reversion to 25 basis point hikes as it seeks to tame inflation. 

“As interest rates approach the RBA’s estimate of the neutral rate of around 2.5%, we expect the Bank to slow the pace of tightening and have pencilled in smaller 25 basis point hikes from September,” Thieliant said. 

He added: “The risk is titled towards additional 50 basis point hikes during the second half of the year … and rates may well peak above our current forecast of 3%.”

AUD adrift from RBA

Analysts at ING also said today they expected a 50 basis points hike to be announced tomorrow – but noted that “a larger, 75bp hike, cannot be fully ruled out.”

However, they said AUD had been largely de-linked from monetary policy and short-term rate dynamics, and was primarily being driven by US dollar moves and the global risk environment.

“Even in the event of a hawkish surprise tomorrow morning, we think the risk is that we see an AUD reaction similar to the one of Norway's krone and Sweden's krona after their respective central banks’ recent hawkish hikes: a very short-lived jump followed by an immediate correction to pre-meeting levels, as markets remain bearish high-beta currencies in the current market environment,” they said. 

 

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