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Australian Dollar May Yield Key Reversal on RBA Rate Decision

Australian Dollar May Yield Key Reversal on RBA Rate Decision

2013-05-04 05:01:00
Ilya Spivak, Head Strategist, APAC
Forex_Australian_Dollar_May_Yield_Key_Reversal_on_RBA_Rate_Decision__body_Picture_5.png, Australian Dollar May Yield Key Reversal on RBA Rate Decision

Fundamental Forecast for Australian Dollar: Bearish

The Australian Dollar will turn its focus to domestic matters once again in the week ahead, with traders setting their sights on the Reserve Bank of Australia’s monetary policy announcement amid rising interest rate cut expectations. Data compiled by Credit Suisse suggests the markets now see a 57 percent probability of a 25bps reduction in the benchmark lending rate, meaning investors’ outlook is at its most dovish since early February. Longer-term expectations are their least supportive since the beginning of December 2012, calling for at least 60bps in accommodation over the coming 12 months.

The fundamental backdrop offers compelling-enough evidence to support the case for stimulus. Australian economic data has shown signs of meaningful deterioration relative to consensus forecasts since April’s RBA sit-down. More worrying still, activity indicators out of China are showing signs of deterioration. The East Asian giant is Australia’s largest trading partner and arguably the most significant source of demand underpinning the pivotal mining sector. This coupled with the negative impact of the relatively strong exchange rate on Australia’s terms of trade bodes ill for the export sector and economic growth at large.

The outlook for inflation also offers the RBA some room to maneuver: while CPI has been ticking higher, price growth expectations baked into government bond yields point to price growth within the 2-3 percent target range over the medium term (generally quantified as about 3 years forward). That seemingly gives the central bank enough room to lower the lending rate in the near term without compromising longer term price stability.

Although rate cut expectations have certainly firmed over recent weeks, there seems to be enough room for ambiguity to produce a meaningful negative response from the Australian Dollar if the central bank does opt to issue a rate cut. This makes for the possibility of a significant trend reversal considering AUDUSD is trading in relatively close proximity to the multi-month range bottom just below the 1.02 figure. An interest rate cut may be just the thing to force a critical downward breakout, a development that would beckon follow-through and potentially mark a longer-term regime change for the Australian unit.

If the RBA opts to remain on hold, the language of the policy statement will become critically important as investors size up the likelihood of a rate cut at the June meeting. It will likewise turn the spotlight on April’s Employment report. Expectations call for the economy to add 11,000 jobs in April after the previous months dismal 36,000 decline marked the worst monthly reading in a decade. Recently disappointing news-flow suggests economists are still underestimating the degree of slowdown at play in the Australian economy, opening the door for a downside surprise. While such an outcome will be moot if the RBA cuts rates, it may carry substantial scope for Aussie weakness if the central bank remains on hold while offering clues about possible future stimulus expansion.

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.