Australian Dollar Strength May Succumb To Interest Rate Expectations

The Reserve Bank of Australia meeting minutes spurred speculation that the central bank may hold a neutral policy going into the following year and curb the pace of rate hikes as the outlook for future policy remains an “open question,” and the drop in the interest rate outlook may drag on the exchange rate as policy makers hold a cautious outlook for future growth. Credit Suisse overnight index swaps shows investors are pricing a 62% chance for a 25bp rate hike next month, which is down from 83% in the previous week, while market participants speculate the central bank to raise borrowing costs by nearly 140bp over the next 12-months as policy makers maintain their dual mandate to ensure price stability while fostering full-employment. The RBA said “business and consumer confidence could prove fragile” over the following year and saw a risk for a protracted recovery as the government stimulus begins to taper off, and went onto say that the outlook for monetary policy “remained an open question” as the board aims to balance the risks for the economy. In addition, the central bank reiterated that the marked appreciation in the Australian dollar is likely to “constrain output and dampen inflationary pressure” going forward, but at the same time, the RBA argued that “a lengthy period with interest rates at a very low level carried its own risk” as the economy skirts the global recession.

At the same time, the Organization for Economic Cooperation and Development raised its economic outlook for the region and expects the growth rate to expand at an annual rate of 2.4% over the following year amid an initial forecast for a 1.2% rise in June, and the group expects to see “a gradual tightening of monetary policy” going forward as growth prospects improve. As a result, the economic docket for the following week is likely to spark increased volatility in the exchange rate as economists forecast business spending to rise 1.0% in the third-quarter after expanding 3.3% during the previous three-month period, while construction outputs are anticipated to hold flat after falling 0.1% in the second quarter.  - DS