Trading the Australian Dollar and the RBA

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The key near-term event for the Australian Dollar is Tuesday's interest rate decision at the Reserve Bank of Australia where another hike is likely.

The guidance regarding the prospect of further rate hikes will, however, be of most concern to currency markets.

"The guidance provided in tomorrow’s policy statement will be key. February's policy statement made it clear that "further increases in interest rates will be needed" to ensure inflation returns to the RBA’s target band within an appropriate timeframe. This led to an increase in market pricing for the cash rate peak, which today sits at around 4.2%," says Pat Bustamante, Senior Economist at St. George Bank.

Foreign exchange strategists at TD Securities say a repeat of the line "further increases in interest rates will be needed" would amount to a 'hawkish' outcome from an Australian Dollar perspective.

"The market is likely to imply this as locking in 25bps rate hikes in April and May," says Alex Loo, Macro Strategist at TD Securities.

Under such an outcome the Aussie Dollar would be expected to rise, with Loo seeing a potential AUD/USD target at 0.68, up from the current level at 0.6730.

All else being equal, this would imply a move lower in the Pound to Australian Dollar exchange rate (GBP/AUD).

TD Securities holds a 35% probability of such an outcome occurring.

Their base case view (40%) however is for the Bank reverts to wording from the December 2022 Statement that "The Board expects to increase interest rates further over the period ahead, but it is not on a pre-set course".

"The market is likely to read this as the Bank being more uncertain and giving itself optionality on the policy rates outlook. In this instance, the next 25bps hike could be April and/or May. OIS is pricing in one more hike over April/May," says Loo.

AUD/USD and GBP/AUD would be expected to be unchanged on such an outcome as it aligns with current expectations.

Money markets show investors are currently priced for the RBA cash rate to go 23bp higher on March 07 to 3.60%, but further hikes are expected to take the peak to 4.20% by September 2023.

A 'dovish' outcome that would see the Australian Dollar lose value would involve the RBA deploying the above-mentioned 'neutral' text as well as reintroducing its desire to wait for lags in monetary policy to play out.

In short, this would suggest the RBA is ready to pause rate hikes to let the run of rate hikes work through the economy.

TD Securities sees a 25% chance of such an outcome transpiring, AUD/USD is forecast to trade to 0.6690, which would imply further GBP/AUD upside, all else being equal.

"Most of the data released since the RBA's "hawkish pivot" have come in soft, adding to evidence that the sharp rise in interest rates over the past year is starting to restrict growth," says Izumi Devalier, Japan and Asia Economist at Bank of America.

She cites January employment data, fourth-quarter wage data and fourth-quarter real GDP growth as evidence of a cooling in the economy that could prompt the RBA into a more 'dovish' direction.

Importantly, the official monthly CPI reading released on March 01 also revealed a surprise to the downside at 7.4% year-on-year vs. expectations for 8.4% in December.

However, Bank of America says they still expect the RBA to hike in March, April and May with guidance staying unchanged this time around.

"The RBA made a very deliberate choice to pivot towards a hawkish direction in its February policy statement and SMP. We think this reflects a shift towards a risk management strategy that recognizes that the cost of doing too little to contain inflation outweighed the cost of doing too much," explains Devalier.

"We remain constructive AUD over the medium-term, forecasting 0.74 by year-end," says strategist Adarsh Sinha at Bank of America.