Red-hot Australian inflation data spurs RBA rate hike speculation

Although it hasn’t felt like it at certain times this year, the AUD/USD has been the second-best performing currency pair after GBP/USD. The common link is that both countries have been dealing with stubborn inflation - a link reinforced today following a red-hot Australian inflation number.

Australian inflation surges

The monthly consumer price index (CPI) indicator, a key data point, unexpectedly surged by 4% year-on-year (YoY) in May, surpassing both the April figure of 3.6% and the consensus forecast of 3.8%. The ex-volatile measure fell to 4% in May from 4.1% in April. However, annual Trimmed Mean inflation surged to 4.4% in May from 4.1% in April.

Today’s monthly CPI indicator, being the second month of the quarter, was skewed towards the sticky services component. At the Reserve Bank of Australia’s (RBA) last board meeting just a week ago, it was noted that “the persistence of services price inflation is a key uncertainty” and “the board remains resolute in its determination to return inflation to target and will do what is necessary to achieve that outcome.”

Hawkish tone from RBA Governor

In the press conference following last week's RBA board meeting, RBA Governor Bullock struck a more hawkish tone. She concluded her opening remarks, noting that "a lot needs to go our way if we want to get inflation back to the target" and stay on the narrow path. She confirmed that the board discussed the option to hike rates but not the option to cut rates.

Trimmed Mean inflation and RBA's forecasts

Today’s rise in the Trimmed Mean to 4.4% puts it well above the RBA’s forecasts from the May Statement of Monetary Policy for Trimmed Mean at 3.8% in June 2024 (chart below). It also raises questions about the RBA’s stated objective to ensure inflation returns to its target band within a reasonable timeframe without further tightening of monetary policy.

RBA growth, unemployment and inflation forecasts chart

Key upcoming data points

The RBA's next board meeting on 6 August is now ‘live,’ and there is a high chance of a 25 basis point (bp) rate hike in August to 4.60%. The only way out is for a series of softer numbers in most, if not all, of the key data points before the August meeting, particularly the last one, which seems unlikely.

• Labour Force Report: Thursday, 18 July
• Retail Sales for June: Friday, 26 July
• Q2 Inflation: Wednesday, 31 July

Global inflation context

As a side note, it’s worth noting that the upside surprise in AU inflation today followed an upside surprise in Canadian inflation last night, which showed a reacceleration driven by elevated shelter and services prices. It appears we are seeing something similar here in Australia, which begs the question: have we seen the low point in this global disinflation cycle?

Monthly CPI indicator annual movement chart

How did firmer CPI data impact the Australian interest rate market?

Ahead of the CPI release, the rates market was pricing in about a 12% chance of a 25 bp RBA rate hike in August to 4.60%; following the data, the odds of a rate hike in August have increased to about 32%. Further out the curve, there are 12 bp of RBA rate hikes priced for September, which equates to about a 40% chance of a 25 bp rate hike from the RBA on 24 September. The timing of the first possible RBA rate cut has been pushed out from December 2024 to April 2025.

Outlook for AUD/USD

Expectations of an RBA rate hike, compared to expectations of a Fed rate cut in September, support the AUD/USD's continuation of outperformance in 2024.

Technically, to increase the chances that the AUD/USD based at the 19 April .6362 low, it must first maintain altitude above the 200-day moving average at .6550. It then must break above the mid-May .6714 high and multi-week trendline resistance at around .6720. In this case, the next upside target would become a cluster of horizontal resistance at .6870/00 before .7000c.

On the downside, if the AUD/USD were to see a sustained fall below the 200-day moving average at .6550, it would warn that a deeper pullback is underway towards support at around .6480, coming from the swing lows of March and April 2024, with scope to the February .6442 low.

AUD/USD daily chart

• _{Source: TradingView. The figures stated are as of 26 June 2024. Past performance is not a reliable indicator of future performance. This report does not contain and is not to be taken as containing any financial product advice or financial product recommendation.}