RBA preview: 25 or 50, and where next for AUD/USD?

As the Reserve Bank of Australia (RBA) prepares to deliver its latest monetary policy decision in under 24 hours, the key question once again will be by how much will they raise rates?

Markets are pricing in a sure chance of a 25 basis point (bps) rate hike being delivered, with a 79% chance of the hike being increased to 50bps as the implied rate in markets for this meeting currently stands at 39bps.

There are arguments to be made for either of the options. RBA governor Philip Lowe confirmed a few weeks ago that the decision to be made by the Board was the size of the hike (25 or 50bps) and that it would be made on the data provided each month as well as the level of rates and inflation. So, let’s look at it.

Strong labour market and retail sales

The most recent data we have is on the housing market, which showed there was still good momentum in new building approvals in the month of May.

On Wednesday last week the latest retail sales, also for the month of May, came in stronger than expected, suggesting that Australian consumers remained resilient in the face of higher inflation. The other data out since the latest meeting was the employment reading for May, which showed an increase in the participation rate and a higher-than-expected addition of active workers. The unemployment rate failed to drop to 3.8% as markets were expecting, coming in unchanged at 3.9%, but remaining at historic lows.

This all suggests the RBA will be comfortably delivering a 50bps hike tomorrow morning. This is also supported by that fact that, despite not having any inflation data out since the last meeting, inflation expectations released by the Melbourne Institute have crept up to 6.7%, getting closer to the 7% peak suggested in the RBA’s latest revision.

Furthermore, the hawkish feeling is spreading rapidly across central banks as inflation continues to rise across the globe, which may give the Board a stronger feeling of comfort when delivering a higher rate, following in the footsteps of the Federal Reserve's (Fed) somewhat unexpected 75bps hike last month.

Concerns about recession continue

On the other hand, some economists have continued to warn of the effects higher interest rates will have on the economy. And it seems like the feeling of concern has spread to the general population as higher costs of living are squeezing consumer’s disposable income.

Whilst higher rates are needed to counteract the effect of inflation on consumers, the negative effects on growth have led many to believe that the central bank may opt to deliver gradual rate hikes in the hopes of bringing down the cost of living without putting the health of the economy at risk.

25 or 50, but why not 75?

If I’m honest, I believe the scales are tipped very much in favour of a 50bps hike, especially when it’s the RBA making the decision. The argument would be very different if this was the Bank of England (BoE).

There is, in fact, some argument to be made in favour of a larger 75bps hike, but the decision seems to be pretty much made up between 25 or 50, and the fact the RBA is meeting monthly, rather than every six weeks like other central banks, takes some of the pressure off this meeting.

AUD/USD struggle persist ahead of RBA meeting

The recent soft environment for commodities has been putting pressure on the AUD’s performance.

The selloff in AUD/USD has been intensified by the risk-off move that swept markets last week, increasing the USD’s safe haven demand in detriment to most pro-cyclical currencies like the AUD.

Friday’s session was particularly tough on the pair, which saw a new two-year low, but buyers were able to come off from the lows which have led to a positive open this morning.

There is still a far stretch to get to 0.70, which would be a bull’s ideal signal that support is taking the pair higher, but the push away from daily lows over the last few weeks shows there is willingness from buyers to keep the pressure in favour of a move higher.

There are currently few signs of exhaustion in the US dollar, even with traders cutting back their positions during this extended weekend because of the US independence holiday.

This suggests that even in the event of a hawkish surprise from the RBA, the upside potential of AUD/USD is limited below 0.70.

AUD/USD daily chart