Market update: Australian dollar spikes after RBA hikes

The Australian dollar roared over 67 cents after the RBA tightened monetary policy following a pause last month. The 25 basis point lift took the cash rate to 3.85%.

In the accompanying statement on monetary policy, the bank said, “Some further tightening of monetary policy may be required to ensure that inflation returns to target in a reasonable timeframe, but that will depend upon how the economy and inflation evolve.”

They highlighted the tight labour market and that wages had started to pick up.

Australian retail sales and trade data will be released this week followed by building approvals figures next week. The Citibank Economic Surprise Index (ESI) in the chart below is leaning toward a possible beat for AUD fundamental coming up.

Prior to the meeting, interest rate markets were pricing on a fifty-fifty chance of a 25 basis point hike later this year. Now that it has arrived, the market is recalibrating and digesting the intonation of the statement. The reaction in AUD/USD has been more abrupt.

It would seem that last week’s inflation figures stoked some flames of concern with headline CPI of 7.0% slightly beating forecasts of 6.9% year-on-year to the end of March and it was against 7.8% previously.

The RBA’s preferred measure of trimmed-mean CPI was 6.6% year-on-year for the same period instead of estimates of 6.7% and 6.9% previously.

The headline CPI figure has been above the RBA’s mandated 2 – 3% inflation target since the second quarter of 2021 while the trimmed mean has been above the target since the first quarter of 2022.

The RBA didn’t start raising the cash rate until May 2022. The shortcomings of the trimmed mean measure may have been exposed by this episode.

This adjusted inflation gauge looks at the middle of 70% of the headline CPI basket. That is, it eliminates the 15% of the basket that rose the most and least.

This symmetric approach means that if one side of the basket is seeing far more aggressive price changes, the other side of the basket being eliminated doesn’t necessarily evenly compensate for it.

When inflation pressures are moving significantly up or down, the value of appraising the underlying price changes using a core method such as the trimmed mean might not be as useful as it has been historically.

What is apparent from today’s decision is that the RBA are back in inflation-fighting mode.

The Federal Reserve and European Central Bank (ECB) will meet late this week while the Bank of England will gather next week. Interest rate markets have priced in a 25 basis point lift by all three central banks.

AUD/USD one minute chart price reaction to RBA hike

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