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The Australian Dollar AU$

AUD/USD NY Spot Close 1.08573

Australian_Dollar_Higher_Inflation_To_Stoke_Rate_Expectations_body_audusd_risk.png, Australian Dollar: Higher Inflation To Stoke Rate Expectations

Australian Dollar: Higher Inflation to Stoke Rate Expectations

Fundamental Forecast for Australian Dollar: Bullish

The Australian dollar broke out of the range-bound price action carried over from earlier this year, and the high-yielding currency may continue to retrace the decline from back in May (1.1011) as the economic docket for the following week is expected to show a heightening risk for inflation. Producer prices are expected to increase at an annualized pace of 3.1% in the second-quarter after expanding 2.9% during the first three-months of 2011, while the headline reading for inflation is expected to climb 3.4% during the same period, which would mark the fastest pace of growth since the fourth-quarter of 2008.

However, in light of the recent comments by the Reserve Bank of Australia, it seems as though the central bank will endorse its wait-and-see approach throughout the second-half of the year, and Governor Glenn Stevens may continue to soften his hawkish tone for monetary policy as the region faces an uneven recovery. As the RBA sees the economy operating below full-capacity until 2012, expectations for a delayed recovery from the Queensland floods certainly dampens the outlook for future growth, and the slowdown in economic activity is likely to weigh on the exchange rate as it curbs the risk for inflation. According to Credit Suisse overnight index swaps, investors see borrowing costs falling by more than 25bp over the next 12-months, and the downturn in interest rate expectations are likely to drag on the exchange rate as market participants weigh the prospects for future policy. In turn, the run at 1.0900 may fail to bear fruit, and the move could turn out to be a false breakout as the fundamentals reinforce a bearish outlook for the high-yielding currency.

Nevertheless, should the inflation reports top market forecasts, the developments are likely to drive the exchange rate higher, and the stickiness in price growth could dampen speculation for a rate cut as the central bank aims to balance the risks for the region. If the data reduces expectations for lower borrowing costs, the near-term rally in the AUD/USD could gather pace in the week ahead, which could lead the high-yielding currency to make a run at the yearly high. - DS