As far as the markets and economists are concerned, Tuesday’s RBA 25 bps rate cut is a done deal. At the last meeting, most economists were surprised when Australia’s central bank decided to keep rates unchanged. The RBA argued that the hold was due to the need for more information on inflation. Since then, Q2 CPI continued to soften. This has left practically everyone thinking that all the data is pointing in one direction, and there is no excuse left to cut rates.
But the RBA’s penchant for not doing what the market expects leaves plenty of room for a surprise. That could push the AUDUSD in a new direction, even if the RBA does cut rates as expected. It could provide some messaging that surprises traders after the meeting and upsets markets.
Why the Disagreement?
Economists and traders looked at the data ahead of the last meeting and figured it all pointed to easing. But that could be because economists (and the market) are using a different set of priorities than the RBA is. It could also explain why economists have been having a challenging job of predicting what interest rates in Australia will be.
The RBA has stressed uncertainty and caution, like most other global central banks. This has left analysts (most of them international) treating the RBA in the same way as its peers. However, Michelle Bullock’s bank is facing some different circumstances, which could explain some of the discrepancies.
What Surprises Are In Store
Australia is a highly export-dependent country, sending raw materials to China. As a result, its central bank needs to be extra cautious around the impact of the trade war. Australia imports a significant amount of goods, particularly energy. Fluctuations in the exchange rate, therefore, can have a substantial effect on consumer prices.
A central bank focusing on maintaining price stability must be particularly cautious about how monetary policy will affect the exchange rate. This puts the RBA in a complicated position more similar to the BOJ than the ECB or the Fed. Small nudges in interest rates can have a significant impact on the currency. Particularly when it is opening the rate cap with the Fed, which can encourage carry trading.
Managing Expectations
Now that the market has fully priced in a rate cut for the coming meeting, the question is what comes after that. And here it seems that the market, at least, is taking the RBA’s cautious approach more seriously. Futures markets suggest there is only a 40% chance of a rate cut from here to December.
Traders will be closely scrutinising Bullock’s comments to see if there is reason to expect easing in December or sooner. The focus will likely be on how much emphasis is put on inflation as opposed to economic growth. More talk of inflation could leave markets pricing out a rate cut. On the other hand, talk about the economy could get markets optimistic about an impending rate cut.
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