AUD outlook: The RBA surprise with a 25bp hike, with potential for more to follow

• The Board decided to increase the cash rate target by 25 basis points to 3.85 per cent
• Inflation in Australia has passed its peak, but at 7 per cent is still too high and it will be some time yet before it is back in the target range
• The Board held interest rates steady last month to provide additional time to assess the state of the economy and the outlook
• The central forecast remains that it takes a couple of years before inflation returns to the top of the target range
• The labour market remains very tight
• Medium-term inflation expectations remain well anchored, and it is important that this remains the case
• Today’s further adjustment in interest rates will help in this regard
• The Board remains alert to the risk that expectations of ongoing high inflation contribute to larger increases in both prices and wages
• …it will continue to pay close attention to both the evolution of labour costs and the price-setting behaviour of firms
• Some further tightening of monetary policy may be required to ensure that inflation returns to target in a reasonable timeframe

The RBA hike after a quick pause for breath

The RBA hiked for an 11^th time this cycle, after a mere 1-month pause following ten consecutive hikes. The market reaction shows how traders have been wrong-footed, with AUD spiking broadly higher with Aussie bond yields and the ASX falling to a three-week low. It’s also worth noting that money markets had priced in a 100% probability of ‘no change’, so to say the RBA have wrong-footed market participants would be quite an understatement.

The cash rate is still relatively low compared with inflation and other central banks

Still, most would agree that a cash rate of 3.85% with inflation at 7% is still too low, and the RBA have left room for further hikes by saying “Some further tightening of monetary policy may be required”. The reality is that the RBA could have simply hiked by 25bp in April because nobody was expecting quarterly CPI to simply roll over in Q1. But it does appear that the central forecast for rates to a ‘couple of years’ to reach their target band was the trigger for today’s decision, and that means we should be on the guard for further hikes. And perhaps they’ll go for a 15bp increment next, to take rates to a nice round 4%.

What does this mean for the Fed?

The RBA are still playing catch-up with a much more hawkish Fed, and odds already favour a 25bp Fed hike irrespective RBA’s decision to tighten today. So at this stage, the Fed are likely to hike to 25bp. And if prior meetings are anything to go by, markets will interpret the statement as dovish to send the dollar lower, before Jerome Powell delivers a more hawkish message at the press conference to send the dollar higher. And given that Fed members were generally hawkish ahead of the blackout period, I’m not anticipating a dovish hike that bond markets are so eager to see.

AUD/JPY daily chart:

The combination of a dovish BOJ meeting on Friday and hawkish RBA today has sent AUD/JPY above its 200-day MA. It also saw a solid close above trend resistance yesterday, and is now within striking distance of its YTD high – a level which is likely to prompt some sort of profit taking or shakeout if it is tested. Beyond that, it looks as though a fresh YTD high could be achieved unless we see a notable reversal in sentiment for global markets.

AUD/USD daily chart:

The Aussie has risen to a five-day high and shows the potential to extend the current rally. However, with the Fed meeting fast approaching and the 200-day MA and EMA nearby, we suspect its rally will be capped. Therefore, we’d prefer to see if the Fed deliver a hike without a dovish undertone to pick a swing high. Although if the Fed were to deliver a dovish hike then we could potentially see this rip higher above 0.6800.

-- Written by Matt Simpson

Follow Matt on Twitter @cLeverEdge

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