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Australia June CPI and the Prospect of More Rate Hikes

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After the RBA left the door open for another rate hike when it meets next week, there is a lot of attention on CPI figures to be released on Wednesday. There was quite a bit of division ahead of the last rate decision, so the surprise of the hold was kind of a technicality. Only 51% of Australian economists expected a rate hike last time around.

What was left in doubt was the evolution of inflation. Australia provides official CPI change data only once per quarter, making tracking the effects of monetary policy much more difficult. It also makes it a much bigger challenge to predict what the RBA will do. For now, the majority of economists aren’t willing to venture a guess as to what will happen at the next meeting until the data comes out.

What to expect

The release of the quarterly CPI change is going to provide analysts with the vital data needed to compile forecasts for the next meeting. Consequently, there could be a strong reaction in the market, as investors price in the chances of a rate hike. For the moment, given the current forecast for inflation, things are set up for a quarter point of tightening from the RBA.

If inflation overshoots, then the expectation for a hike would solidify, and the Aussie could get a little stronger. On the other hand, a substantial undershoot of inflation could reverse bets of a rate hike and weaken the Aussie. And we should remember that substantial underperformance in consumer prices has been a trend lately.

What the data says

Quarterly Australian CPI change for Q2 is expected to drop to 1.1% from 1.4% reported previously. That would bring the annual rate down to 6.3% from 7.0% in the first quarter. At that rate, it is still tripling the midpoint of the RBA’s target range, and more than doubling the top end of the range.

But what the RBA tracks most closely for its policy decisions is the Weighted Median CPI Change, which is expected to decline on a quarterly basis to 1.0% from 1.2% prior. The annual rate is expected to have a less pronounced reduction, down to 5.5% from 5.8% prior.

Where the market could go

Money markets are pricing in 50 bps of more hikes this year, before the RBA reaches its peak rate. That implies two more hikes, with just three more meetings. If the data comes in enough to convince traders that there won’t be a rate hike next week, then the clock is fast running out for two hikes. Which could mean that the market might pull back on its expectations for the peak rate and drag down the Aussie with it.

On the other hand, the further expected rate hikes are seen raising the risk of a recession in Australia. The latest survey of economists says that the chance of a recession later this year has risen to 50%, from 34% the last time the survey was conducted in May. Even though the expectation of more rate hikes would be expected to support the Aussie on the basis of higher interest rates, investors could worry more about a recession. And that would ultimately be negative for the Australian dollar as well. That might cap the potential upside from an inflation overshoot or cause any jump to the upside to fade relatively quickly.

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