RBA Sends Australian Dollar Higher with 'Cut and Wait' Stance, Can go Higher says One Analyst

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- RBA cuts Australian interest rates to record low of 1.0%.

- But signals not in a rush to cut again, sending AUD higher.

- ANZ says August forecasts toreveal need for further cuts.

- CBA looks for AUD appreciation through summer months.

- Westpac says Fed outlook now key to AUD performance.

The Australian Dollar rose to the top of the G10 league table Tuesday after the Reserve Bank of Australia (RBA) appeared to water down its commitment to further interest rate cuts, after delivering a second reduction in Aussie borrowing costs in just as many months. 

Governor Philip Lowe said Tuesday the cash rate has been reduced by a further 25 basis points to a fresh record low of 1% but he added at the end of the monetary policy statement that the bank will now wait "monitor developments in the labour market closely and adjust monetary policy if needed". 

The words "if needed" have left analysts with the impression the additional and third rate cut that markets have been betting will come inside of 2019 may no longer be a forgone conclusion. Governor Lowe will deliver a speech at 10:30 pm Tuesday that will now be watched closely for clues on the outlook. 

 "The Aussie seemed to be torn between delivery of a rate cut that was not fully priced for this meeting and the statement wording which suggested no urgency to cut again," says David Plank, head of Australian economics at Australia & New Zealand Banking Group. "While this change is subtle, we think it reflects the fact that with rates 50bp lower the case for further easing is not necessarily as pressing as it was." 

Above: Australian Dollar performance Vs G10 rivals Tuesday.

As before the Governor made future changes in interest rates contingent upon the developments in the labour market because it's jobs growth the bank sees as the key to its inflation target, which the RBA has missed for much of the time since the end of 2014. 

Australian inflation has been below the 2%-to-3% target for years now, which has left the RBA in pursuit of lower unemployment, higher wages and the faster economic growth that would come with it as a means of achieving its target for consumer price pressures.

The bank is expected to update its economic forecasts in August, which should then provide markets with a clearer view of just how much more 'easing' the RBA thinks will be required in order to get inflation higher. 

"We struggle to see how these forecasts can conclude anything other than further stimulus is needed to achieve the target the RBA has set itself – namely, an unemployment rate of 4.5%. The two rate cuts built into the May forecasts was not expected to get the economy to this point and we don’t see anything since then that will prompt the RBA to revise the growth outlook higher. So our base case remains that the RBA will ease again in August," says ANZ's Plank.

Above: Pound-to-Australian-Dollar rate shown at daily intervals.

Changes in interest rates are normally only made in response to movements in inflation but impact currencies because of the push and pull influence they have over capital flows, and their allure for short-term speculators.

Capital flows tend to move in the direction of the most advantageous or improving returns, with a threat of lower rates normally seeing investors driven out of and deterred away from a currency. Rising rates have the opposite effect.

The Aussie's positive reaction to Tuesday's rate cut is seen as a result of the market having correctly anticipated the move and then some over the coming months. In other words, the cut was already in the price of the Aussie. 

"We anticipate the RBA to pause until November, and for the AUD/USD to appreciate between now and then as the Fed begins cutting interest rates at the end of this month," says Kim Mundy at Commonwealth Bank of Australia. 

Above: AUD/USD rate at daily intervals, alongside AU-U.S. 2-year yield gap (orange line, left axis).

Mundy and the Commonwealth team say the Australian Dollar has already paid for the RBA cuts that markets are betting on and that future reductions to the cash rate should not harm the currency, especially as the Federal Reserve is expected to begin cutting its interest rate in July. 

CBA forecasts the AUD/USD rate will rise to 0.72 by year-end. The Pound-to-Aussie rate is expected to fall from 1.8069 to 1.7777 over the same period.

This is not out of sync with the view advocated by Westpac, another of Australia's largest lenders, on Tuesday. Westpac says the AUD/USD outlook will now depend heavily on what the Fed does, although they too doubt the U.S. central bank will deliver the level of stimulus that markets are betting on.

"This year we have seen AUD/USD correlating far more reliably with yield differentials than with commodity prices," says Sean Callow, a strategist at Westpac. "This sensitivity to the monetary policy outlook suggests that while AUD/USD could get some further support from an upbeat Lowe speech, rallies will be capped if Fed officials and/or US data provide further cause to trim pricing for FOMC easing. In particular, we see no good reason why Fed fund futures should still be pricing a 20% risk of -50bp on 31 July." 

Above: AUD/USD rate shown at daily intervals, alongside Pound-to-Aussie rate (aqua line, left axis).

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