Australian Dollar: Next Move Could be an Interest Rate Hike Warn Economists

Above: File image of Michelle Bullock. Image © RBA

The Australian Dollar could be poised to extend its current run of outperformance if the Reserve Bank of Australia were to raise interest rates again.

The prospect of another interest rate hike has become more likely after Australia's first-quarter inflation figures revealed the process of disinflation was at risk of stalling, with some key measures starting to rise again.

"Time to worry about a hike?" asks David Forrester, Senior FX Strategist at Crédit Agricole in Singapore. "Australia’s inflation has slowed by significantly less than the RBA had hoped."

The Australian Dollar was the best-performing major currency on the day the ABS said CPI inflation rose 3.6% year-on-year in the first quarter, which was stronger than the 3.4% outturn the market was expecting.

It was the report's details that will worry the RBA: inflation accelerated on a quarter-to-quarter basis from 0.6% in Q4 to 1.0% in Q1 which indicates the more timely measures show inflation is picking up again.

The core measures of inflation that the RBA tracks closely also showed signs of increasing price pressures: the weighed mean accelerated from 0.9% to 1.1% q/q while the trimmed mean quickened from 0.8% to 1.0% q/q.

"All told, the data reinforce our conviction that the RBA is unlikely to cut rates before Q4. If anything, the slew of upside surprises raise the risk that the Bank will feel the need to hike rates further," says Abhijit Surya, Australia and New Zealand Economist at Capital Economics.

Crédit Agricole says the RBA will have to revise up its inflation forecasts given recent trends and delay the return of inflation to its target band 2-3% target band, "which the central bank has indicated in the past would trigger a rate hike".

"The Australian Dollar would be in a position to make further gains against the likes of the Pound and Euro in the coming months if the RBA does proceed with an interest rate hike," says Russell Gous, advisor at MoneyTransfer.com.au.

Higher interest rates at the RBA will trigger higher rates on consumer- and business-facing loans, which will slow economic activity and bring inflation down. But, it also makes the vast Australian debt markets more attractive to international investors as higher interest rates mean a higher return.

Above: The AUD is the best performer in G10 when screened over the past week. Track AUD with your own custom rate alerts. Set Up Here

This can attract capital into Australia, thereby boosting the value of the Aussie Dollar, particularly against currencies belonging to central banks that are cutting interest rates.

Michele Bullock, the RBA Governor, said in February, "we haven’t ruled anything out and we haven’t ruled anything in," regarding whether it will cut or raise interest rates.

She added that the Board has a low tolerance for upside inflation surprises and a later return of inflation to the target band.

"The RBA will come out hawkish at its 7 May meeting and it is appropriate for the market to price out rate cuts for 2024, for now. A rate hike is unlikely at this stage as a second wave of large mortgage rollovers began in March and peaks in June. The RBA will want to see the impact of these rollovers on households before making its next move," says Forrester.

Crédit Agricole thinks a November rate cut is still likely, a view shared by the majority of domestic banks.

Nevertheless, we expect to see increased chatter of a rate hike, and this can act to underpin the Australian Dollar.

"For the AUD, we feel that diverging monetary policy expectations, widening yield differentials, and Australia’s sturdier economic fundamentals should support pairs like AUD/EUR, AUD/GBP, and AUD/NZD," says APAC currency strategist Peter Dragicevich at Corpay.