Australian Dollar Tumbles as RBA Unexpectedly Holds Interest Rates at 3.75%

Key Overnight Developments

• Australian Business Confidence Falls Most in 11 Months on China Outlook
• RBA Unexpectedly Holds Interest Rates Unchanged, Sinks Aussie Dollar

Critical Levels



The Euro was little changed in overnight trading, testing as low as 1.3887 but rebounding higher to yield an effectively flat result late into the session. The British Pound inched lower, losing as much as 0.3% against the Dollar. We remain short EURUSD at 1.4881.

Asia Session Highlights



A gauge of Australian Business Confidence dropped the most in 11 months in December according to a report from National Australia Bank. The details of the report looked ominous, with companies’ outlook on export sales and forward orders leading the metric lower. The outcome likely reflects expectations of the fallout from a series of actions taken by Chinese authorities over recent weeks to rein in lending on fears that the buoyant economy may overheat, particularly after stronger than expected readings on the latest growth and inflation figures. China is Australia’s largest export market and a key driver behind the mining boom that has helped keep the economy relatively insulated from the global downturn of the past two years. This means that a significant slowdown in Chinese demand bodes ill for the larger antipodean nation, particularly now that the self-sufficiency of the recovery is tested stimulus is being withdrawn.

The headwinds facing the Australian economy were not lost on the Reserve Bank of Australia as policymakers unexpectedly opted to leave benchmark interest rates unchanged at 3.75% amid forecasts calling for the fourth consecutive 25 basis point increase to 4.00%. The Australian Dollar tumbled on the announcement, shedding over on average 1% against its major counterparts. RBA Governor Glenn Stevens said that while the “risk of serious economic contraction in Australia has passed…lenders have generally raised rates a little more than [benchmark borrowing costs] over recent months,” seemingly suggesting that the central bank was holding off this time around to make sure that it did not overshoot on tightening. To that effect, Stevens assured that the RBA “considers it likely that monetary policy will…need to be adjusted further” to control inflation. However, the RBA chief also acknowledged that “Chinese authorities are now seeking to reduce the degree of stimulus to their economy,” which looks likely to weigh on the rebound in labor and equity markets, both of which Stevens identified as key to supporting household finances (i.e. private consumption) in the absence of fiscal stimulus. If slowing mining demand slows job growth while consumer confidence evaporates with stock gains, the antipodean economy’s resilience may be put to the test in a major way.


Euro Session: What to Expect



The economic calendar looks fairly tame in European hours. German Retail Sales are expected to shrink -2.5% in the year to December, a narrowly better outcome than the -2.8% annual drop registered in the previous month. In monthly terms, receipts are set to rise 0.9%. The marginal improvement is unlikely to offer much support to the Euro however, with traders tempted to chalk up any upswing in December to seasonal factors, particularly after the more forward-looking German Retail PMI showed that the sector shrank at the fastest pace in a year in January. January’s UK Construction PMI seems even more forgettable as expectations call for a reading that is only a hair lower than the previous month’s result.

On balance, risk appetite is likely to dominate price action once again. A reaction to the underlying themes (most notably, that of a Chinese slowdown) behind Australia’s surprising interest rate decision seems to suggest the path of least resistance leads lower for risky assets in the near term, an outcome seemingly supported as US equity index futures trade down about 0.2% ahead of the opening bell.

For real time news and analysis, please visit http://forexstream.dailyfx.com

To receive future articles by email, please contact Ilya at ispivak@dailyfx.com