Where next for AUD after 50bps rate hike?

RBA hike brings cash rate to 0.85%

The Reserve Bank of Australia (RBA) has delivered a 50-basis point (bps) hike in its June meeting, bringing the cash rate to 0.85%.

The move wasn’t completely unexpected as markets were leaning towards a larger hike than the 25bps in the days leading up to the meeting, but the move is still a bold one from the central bank at a time when increased focus is being placed on balancing soaring inflation and signs of stagnating growth.

Market reaction

The reaction in the market after the meeting seems to reflect the uncertainty from traders about whether this was the right move.

The Australian dollar (AUD) jumped higher on the announcement of the 50bps hike but retreated almost immediately back towards where it had first set off. I suspect a smaller 25bps hike might have had a more pleasing outcome for AUD bulls.

Hopes for a “soft landing”, where inflation is brought down lower without hindering growth too much, are still present in the market, but today’s 50bps move from the RBA is likely to have rocked many people’s faith a little bit, leaving the path for the AUD slightly unclear in the immediate future.

Key takeaway

The key takeaway from the meeting statement is the need to bring down inflation - no surprise there.

Governor Philip Lowe is stern in his message about removing the extraordinary monetary support introduced during the pandemic, which he now sees as unnecessary given the level of growth in economic activity, the labour market, and price pressures.

There is a hawkish tone all over the statement as the RBA is expecting inflation to rise further, especially as commodity prices continue to rise, pushing up household spending on electricity, gas, and petrol, suggesting further interest rate hikes in the near future.

This is where market participants have likely been somewhat spooked, as the statement seems to suggest that the governing council is oblivious to the current sensation of risk aversion looming in the market, with many expecting a recession to follow shortly. To attest to that point, the RBA points out the strong labour market in Australia, with unemployment down to 3.9% - its lowest rate in almost 50 years.

At first glance, this data is great news for the economy, but many likely have a bad feeling in the back of their mind, as economic recession usually follows a period of strong economic conditions, when unemployment is at its lows.

Combatting soaring inflation

All in all, the June meeting has proved that the RBA is still focused on combatting soaring inflation without getting too caught up on concerns about stagnant growth given the latest gross domestic product (GDP) readings have continued to show economic expansion.

Market jitters about stagflation haven’t factored into the bank’s monetary policy decision, which has shown more boldness than what is expected from the Federal Reserve (Fed) and the Bank of England (BoE) next week.

The reaction in the Australian dollar, most notably in AUD/USD, has proved that market participants don’t exactly agree with the bank’s aggressive tightening path but the weakness in the pair can also be attributed by a pickup in USD bulls and a slight correction after four weeks of strong performance from the Aussie dollar.