GBP/AUD Rate: Holding Tight Following RBA Rate Hike

• RBA hikes 25bp, in line with expectations
• But raises inflation forecasts
• Could mean it continues to hike into 2023
• Rumours out of China holds AUD

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The Reserve Bank of Australia raised interest rates by 25 basis points today and signalled it was in a wait-and-see mode regarding further hikes, however it could be speculation regarding the future of China's 'zero covid' policy that could be of greater consequence to the Aussie Dollar.

The Pound to Australian Dollar exchange rate (GBP/AUD) was higher at the start of a new month following the 25bp rate hike, but gains would likely have been more significant were it not for reports China's government is forming a body to oversee the country's transition out of its strict zero covid policy.

There had been expectations in some corners of the market that the RBA would go with a 50bp move following October's hot inflation reading, something analysts said would boost the Australian Dollar.

Therefore the 25bp hike, and an overall dovish statement from the RBA, were on the AUD-negative side of the spectrum.

The RBA stuck with the consensus expectation and signalled that further modest rate hikes were coming, saying it "expects to increase interest rates further over the period ahead. It is closely monitoring the global economy, household spending and wage and price setting behaviour."

The RBA confirmed in a statement that any further rate hikes would be dependent on the incoming data, saying "the size and timing of future interest rate increases will continue to be determined by the incoming data and the Board’s assessment of the outlook for inflation and the labour market."

However, it is clear the RBA is at the tail-end of its hiking cycle and could be amongst the first of the major central banks to halt the rate hiking cycle.

This could potentially deny the Australian Dollar support from the interest rates channel.

The RBA lifted the forecast for inflation in 2022 from 7.8% to 8.0% and the forecast for 2023 from 4.3% to 4.75%.

Forecast GDP growth rates were lowered to 1.5% (from 1.8%) in 2023 and 1.5% (from 1.7%) in 2024.

"Another 25bp at the December meeting remains our economists’ base case," says Adam Cole, Chief Currency Strategist at RBC Capital Markets.

The currency market reaction was relatively sanguine with the Australian Dollar mixed in the hours following the decision.

GBP/AUD was up by 0.20% at 1.7924, taking Aussie payment rates at a typical high-street bank to around 1.7422 and those at payment specialists to around 1.7870.

But against the U.S. Dollar the Aussie was up half a percent at 0.6436, amidst a broadly softer U.S. Dollar.

The RBA slowed down the pace it raises interest rates in October when it hiked 25bp, having gone with four consecutive 50bp hikes.

The RBA said it was ready to slow the pace of hikes in order to allow for the lag recent rate hikes would have on the economy, allowing it to assess the impact of these previous hikes.

However, economists at Westpac say the RBA is going to find they will need to do more to get inflation down.

"Going forward we now expect 25 basis point increments in December; February; March and May," says Bill Evans, Chief Economist at Westpac.

He says inflation will become more entrenched in the near-term, meaning a longer hiking cycle.

"It now seems that the Board is prepared to await the impact of the series of hikes at that risk of embedding an inflation psychology in the system which would eventually require a much more damaging policy response," says Evans.

Looking ahead, it could be China's approach to zero covid policy that holds the keys to Australian Dollar price action.

Chinese stocks were higher and the yuan strengthened as speculation mounted that policymakers are making preparations to gradually exit stringent Covid restrictions.

The Australian economy is highly exposed to China and the recent slump in economic activity in the world's second-largest economy has had negative implications for Australia and its currency.

Bloomberg reports unverified social media posts circulated online that a committee was being formed to assess scenarios on how to exit Covid Zero.

The news follows a heavy bout of selling following the Communist Party congress, where President Xi Jinping's 'power grab' led to expectations that Covid Zero and other market-unfriendly policies will likely persist.