The Reserve Bank of Australia is near universally expected to keep rates on hold at the conclusion of its policy meeting on Tuesday. Given the movement in the data recently, there will be a lot of focus on what it signals is coming at the October meeting. Which creates an unusual situation where CPI figures coming out a day after the central bank meeting could end up being the big mover for the currency.
With inflation in the antipodean nation staying stubbornly well above target, the RBA has consistently signaled that it is open to raising rates. But, it hasn’t done so. Markets are on high alert for when for the RBA Rate Decision gives up on its hawkish stance and admits that the next move will be a cut. There is growing expectation that this could be the time, setting up a situation where the Aussie could move in either direction depending on whether expectations are met.
Dark Clouds on the Horizon
One of the main worries of a central bank keeping rates in restrictive territory is that it can be seen as causing the economy to not just decelerate but fall into stagnation or recession. So Monday’s flash PMI figures likely caused a bit of consternation as the RBA Rate Decision starts its two-day meeting. Both Services and Manufacturing PMI came in well below expectations and lower than the prior month, with the Composite measure falling into contraction for the first time in years.
Meanwhile, the AUDUSD is at the highest level it has been this year, after the Fed cut rates by 50bps last week. This narrowed the gap between the two interest rates substantially. While the strong currency could help address inflationary problems by lowering the cost of imports, it will be seen as a problem for an export-driven economy by driving up the cost of exports. The currency was also bolstered by a strong employment report last week. But jobs numbers are typically a lagging indicator, while PMIs are seen as a leading one. Implying that the situation giving strength to the Aussie could be fading quickly.
Holding on to Strength
At the last meeting when the RBA decided to keep rates unchanged, it struck a hawkish tone, focusing on how inflation hadn’t come down. But markets are expecting that situation to change, with the median forecast for August CPI at 2.7%. That’s a major drop from the 3.5%, though it is seen supported in part by lower fuel prices, something that has proven to be a bit transitory with reflaring tensions in the Middle East over the last couple of weeks. The core rate, however, is expected to keep moving lower to reach 3.7% from 3.8%.
The RBA is likely to have that in mind when meeting, and could be determinate in how hawkish the policy statement will be. Markets are unwilling to price in a rate cut for October, but do see one cut before the end of the year – barely. 90% of international economists, however, expect rates to remain unchanged until the end of the year.
The Market Reaction
With markets pricing in a 10% chance of a rate cut, there is some chance for a hawkish surprise. The markets are looking for at least some softening of the statement, so if the RBA comes out as aggressive as it was before, then the Aussie might have some additional headroom.
On the other hand, if the RBA does finally deliver its pivot, suggesting that a rate hike is unlikely, or that the next move is likely to be a cut, then the Aussie might have peaked. Given the disparity in expectations, there is more room to the downside if the RBA comes out more dovish than hawkish.