Aus Dollar: ANZ Forecast a May Interest Rate Cut Despite Higher Inflation

The Australian dollar (AUD) is a top performer in global currency markets following the Q1 inflation data release.

Australian inflation came in marginally ahead of expectations - both the trimmed and weighted medians came in a tick above at 2.3% and 2.4%, respectively.

The currency markets reacted by buying the Aussie dollar as they believe these inflation figures will scare the Reserve Bank of Australia (RBA) away from an addtional interest rate cut:

• The British pound v Australian dollar exchange rate (GBP-AUD) fell to 1.9353. However, the pair did recover following the release of the Bank of England MPC minutes.
• The euro v Australian dollar exchange rate (EUR-AUD) fell 0.9 pct to reach 1.3797.
• The Australian v US dollar exchange rate (AUD-USD) surged 0.75% to reach 0.7769.

Will There be Another Interest Rate Cut in Australia?

Could the rally being put in by the Aus dollar be justified, or is this merely a bounce within a longer-term downtrend?

We have warned in a previous piece that the Australian currency would see short-term strength on the back of Chinese stimulus efforts announced in April.

However, it is argued that the Chinese boost will prove temporary and the Reserve Bank of Australia would need to cut interest rates to further stimulate the Australian economy.

The rule of thumb remains that interest rate rises = a stronger currency, interest rate cuts = a weaker currency.

Currency traders are presently betting that the higher inflation reading from April will scare the RBA from cutting interest rates further as rate cuts risk stoking inflation further.

However, Riki Polygenis at ANZ Research says he and his team are looking through these figures and are betting the RBA will take a similar approach.

“We retain the view that the RBA will cut the cash rate further in May on the basis of weak outlook for domestic demand, particularly non-mining business investment,” says Polygenis.

ANZ concede that is admittedly a close call given uncertainty around the efficacy of rate cuts in the current environment of low yields and high levels of household debt.

“Beyond that, we expect the cash rate to remain on hold until 2017, with the RBA to retaining an easing bias for a considerable period,” says Polygenis.

Ultimately the latest figures shouldn’t materially change the RBA’s moderate inflation outlook, which is neither too weak nor too strong.

Underlying inflation was in line with the RBA’s recent forecasts, and there is not enough in the detail to suggest a change in key inflation drivers and as such we think the markets could be getting ahead of themselves here.