Australian Dollar declines despite RBA rate hike warning
- RBA’s Kent noted rate hikes are working, though further increases remain possible if risks emerge.
- Softer US PPI inflation data cooled Fed rate hike bets, providing support for the AUD/USD pair.
- Markets reduced the probability of a September Fed rate hike to 34.8% following weak inflation figures.
AUD/USD edges lower for the third successive day, trading around 0.7060 during the Asian hours on Friday. Reserve Bank of Australia (RBA) Assistant Governor Chris Kent stated on Thursday that recent interest rate hikes are producing their intended effect. However, Kent cautioned that further rate increases remain on the table should new inflationary risks emerge.
RBA tightening seen biting as Aussie strength and housing slowdown curb demand
Analysts at BNY Mellon underline that the RBA’s earlier rate hikes are now clearly feeding through to the real economy, noting that “higher borrowing costs, rising mortgage payments, weaker established housing market conditions and a stronger Australian dollar have all tightened financial conditions, while aggregate demand is slowing as intended to help return inflation to target.” This combination of softer housing activity and currency strength is seen as consistent with a monetary stance that is now somewhat restrictive and working to steer inflation back toward the RBA’s target band.
Despite potential pressure on the Australian Dollar (AUD), the downside for the AUD/USD pair may be limited due to a weakening US Dollar (USD) following a softer-than-expected US inflation report. Market attention is now shifting toward the US July Retail Sales data scheduled for release later on Friday.
Adding to the inflation picture, the Bureau of Labor Statistics (BLS) reported that US wholesale costs for goods and services were flat in July, cooling more than the anticipated 0.2% growth following a revised 0.1% decline in June. Excluding volatile food and energy components, the core Producer Price Index (PPI) rose 0.2%, coming in slightly below the market consensus of 0.3%. On an annual basis, headline PPI climbed 4.7% year-over-year in July, while core PPI increased 4.2% over the same period.
These cooling inflation metrics have shifted expectations regarding Federal Reserve policy. According to the CME FedWatch Tool, markets are now pricing in a 34.8% probability of a U.S. rate hike at the upcoming September meeting, down from 40% immediately following the PPI data release.
Australian Dollar FAQs
One of the most significant factors for the Australian Dollar (AUD) is the level of interest rates set by the Reserve Bank of Australia (RBA). Because Australia is a resource-rich country another key driver is the price of its biggest export, Iron Ore. The health of the Chinese economy, its largest trading partner, is a factor, as well as inflation in Australia, its growth rate and Trade Balance. Market sentiment – whether investors are taking on more risky assets (risk-on) or seeking safe-havens (risk-off) – is also a factor, with risk-on positive for AUD.
The Reserve Bank of Australia (RBA) influences the Australian Dollar (AUD) by setting the level of interest rates that Australian banks can lend to each other. This influences the level of interest rates in the economy as a whole. The main goal of the RBA is to maintain a stable inflation rate of 2-3% by adjusting interest rates up or down. Relatively high interest rates compared to other major central banks support the AUD, and the opposite for relatively low. The RBA can also use quantitative easing and tightening to influence credit conditions, with the former AUD-negative and the latter AUD-positive.
China is Australia’s largest trading partner so the health of the Chinese economy is a major influence on the value of the Australian Dollar (AUD). When the Chinese economy is doing well it purchases more raw materials, goods and services from Australia, lifting demand for the AUD, and pushing up its value. The opposite is the case when the Chinese economy is not growing as fast as expected. Positive or negative surprises in Chinese growth data, therefore, often have a direct impact on the Australian Dollar and its pairs.
Iron Ore is Australia’s largest export, accounting for $118 billion a year according to data from 2021, with China as its primary destination. The price of Iron Ore, therefore, can be a driver of the Australian Dollar. Generally, if the price of Iron Ore rises, AUD also goes up, as aggregate demand for the currency increases. The opposite is the case if the price of Iron Ore falls. Higher Iron Ore prices also tend to result in a greater likelihood of a positive Trade Balance for Australia, which is also positive of the AUD.
The Trade Balance, which is the difference between what a country earns from its exports versus what it pays for its imports, is another factor that can influence the value of the Australian Dollar. If Australia produces highly sought after exports, then its currency will gain in value purely from the surplus demand created from foreign buyers seeking to purchase its exports versus what it spends to purchase imports. Therefore, a positive net Trade Balance strengthens the AUD, with the opposite effect if the Trade Balance is negative.