RBA May Preview: Aussie at risk ahead of RBA meeting

With declining inflation in the first quarter, expectations are divided for the RBA to announce a 25bps rate cut at tomorrow’s May monetary policy meeting. While it is unclear what the RBA will do, we expect to see a near term decline in AUDUSD to 0.734.

A new trading month and the Reserve Bank of Australia will be the first of the bat, scheduled to meet early tomorrow. Only until a week ago, expectations for a 25bps rate cut were merely 16%, as of April 19th. Thanks to the inflation data for the first quarter released last week showing a weak print, the expectations for a rate cut jumped to 58% as of 29th April, reflecting what could be a close call from the RBA tomorrow.

Australia’s Q1 CPI falls 0.20%, increasing probability for a rate cut

Near term inflation has declined. In the first three months of 2016, Australia’s headline CPI fell 0.20% and posted a modest increase of 1.30% on a year over year basis, data from the Australian Bureau of Statistics showed last Wednesday. Economists were expecting to see a year over year gain of 1.70% instead, which was clearly missed. The RBA’s inflation target is in the range of 2% – 3% and this miss in inflation is being seen as a reason for the increase in the rate cut probability. Inflation fell due to falling fuel and food prices but was offset by an increase in medical and education costs. Stripping the volatile components such as fresh food and energy, consumer price index increased 0.20% in the first quarter of 2016. It was lower than estimates of a 0.50% expectation.

The Australian dollar fell sharply after the release of the CPI data, falling by over 1% on the day, to trade near $0.764 and marked a strong decline after the Aussie rallied for nearly 3-months previously. But the RBA’s decision tomorrow is not an open and shut case with the argument that the central bank could look beyond a short term blip and rather focus on the medium – long term inflation expectations.

Besides the monetary policy decision tomorrow, on May 6th the RBA will be releasing its Statements on Monetary Policy, which is released four times a year. The SMP offers the RBA’s assessment of the current economic conditions and prospects for inflation and growth. The previous SMP was released on February 2016, where the central bank noted that while inflation has declined due to oil prices, they have not changed materially. Back then the RBA acknowledged that underlying inflation is expected to remain low over the forecast period.

In the event that the RBA does not cut rates tomorrow and instead will look to the June meeting, then some jawboning of the Australian dollar is required to stem the recent appreciation. The weekly chart for AUDUSD points to a downside bias with the hidden divergence pointing to a move towards a test of support at 0.734, which was previously a strong resistance level. While it is too early to tell if the declines will continue, price action near 0.734 will be important, as a weekly close with bearish candlestick at this support could see further downside continuation. However, if prices stall at 0.734 with a bullish pattern, we could expect a stronger and sustained move to the upside.