Australian dollar hostage to external factors but RBA might have more work to do

The Australian dollar is currently captive to swings in sentiment of risk appetite. The equity market rally into the end of last week boosted the Aussie before the mood soured to start this week.

The global-growth-linked currency is in a somewhat unique position. Rising fears of a US recession has seen the growth outlook diminish on the back of the Federal Reserve seeking to rein in inflation.

In order to get the annual headline inflation down from 8.6% and toward their target of 2%, severe tightening will be needed.

The US has never lowered inflation by more than 2% without experiencing a recession. The question appears to be the depth and duration of the slowdown.

Last week, Fed Chair Powell highlighted that if supply chains loosen up, the downturn may not be so severe. But if they do not, then the contraction in growth could be painful.

A slow US economy is likely to make China’s post pandemic economic recovery more difficult. China is a major customer of Australian exports.

Amidst recent positive sentiment, Chinese equities got a lift over the last week with some good news of Shanghai re-opening after lockdowns.

This is in contrast to the price action in industrial metals that saw tin and copper down over 20% from recent peaks. Iron ore is also languishing. These metals have been battered by concerns of the Chinese growth outlook.

Australia’s trade balance has kicked in circa AUD 10 billion a month due to the Ukraine war lifting the commodity prices of many of Australia’s exports. It remains to be seen if rosy picture can be maintained.

In the background, the RBA have joined other central banks on a robust tightening regime. Last week RBA Governor Philip Lowe sounded the alarm bell on inflation and the cash rate. December annual CPI is anticipated by the bank to be around 7% and the cash rate could be at 2.5%. It is currently 0.85%. If we break down the CPI numbers, 7% inflation could be here sooner than December.

Second quarter 2021 CPI was 0.8% and this number will drop off the CPI reading that is due out 27th July. First quarter 2022 CPI was 2.1%.

The first three months of the year only includes one-month of the massive surge in commodity prices, notably energy and food. The largest increases in production costs were yet to be fully passed through to the consumer.

If we assume that second quarter 2022 CPI comes in at the same rate as the first quarter (2.1%), that will give us annual read of 6.3%.

Looking at the extraordinary rise in energy, food and building materials over the second quarter of this year, there is a strong chance of much higher number.

The question remains, will an even more hawkish RBA lift the Australian dollar?

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