Australian Dollar Outperforms as RBA Turns Hawkish Once More

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The Australian Dollar was stronger after the Reserve Bank of Australia (RBA) raised interest rates by 25 basis points and signalled it had more work to do.

The decision takes the cash rate to 3.35% – the highest since September 2012 - and the Board said in a statement it "expects that further increases in interest rates will be needed over the months ahead to ensure that inflation returns to target and that this period of high inflation is only temporary."

The RBA is therefore by no means done, suggesting the Australian Dollar can count on support from higher interest rates over the coming months.

"The tone of the statement was arguably more hawkish than December. The language was stronger around the RBA’s resolve to bring inflation back to the target. In fact, the statement all but confirmed that more interest rate increases are on the horizon," says Jarek Kowcza, Senior Economist at St. George Bank in Sydney.

The Bank of Canada in January said it would pause its interest rate hiking cycle and some analysts drew parallels with the RBA which had also been sounding more cautious of late.

However, surprisingly strong inflation and ongoing domestic economic strength have shifted the RBA's thinking.

The Australian Dollar was firmer across the board with the Pound to Australian Dollar exchange rate trading half a percent down at 1.7375.

Above: GBP/AUD (top) and AUD/USD. Consider setting a free FX rate alert here to better time your payment requirements.

"AUD is the best performer overnight, boosted by a clearly hawkish RBA, something we haven’t seen from them since ~Q3 last year," says Elsa Lignos, Global Head FX Strategy at RBC Capital Markets.

The fall in GBP/AUD spot takes bank transfer rates at a typical bank to around 1.6889, cash and holiday rates at competitive providers to around 1.7048 and transfer rates at competitive providers to around 1.7323.

Against the U.S. Dollar, the Aussie was 0.80% higher at $0.6938. The Euro to Australian Dollar exchange rate was 0.65% lower at 1.5483.

"The RBA is getting closer to a cash rate peak, but there is still some way to go. The RBA has signalled that underlying inflationary pressures are likely to remain elevated. Further rate hikes will be required to ensure that inflation expectations remain well anchored, and that inflation is brought back towards the 2-3% target band over time," says Kowcza.

Australia's CPI inflation rate reached 7.8% in the year to the December quarter, the highest since 1990, and the RBA says this is partly explained by strong domestic demand.

It also noted the labour market remains very tight and wage growth continues to pick up.

Following the RBA hike and guidance money markets show investors are now pricing in a peak base rate at 3.9%, up from 3.6% ahead of the decision.

"But we think this is still underestimating how far the RBA will go.
Our projections see rates hit 4.1% in the second quarter, and a potential first rate cut only in the fourth quarter," says Francesco Pesole, FX Strategist at ING Bank.

"We continue to see AUD as the most attractive currency in G10 in the months ahead," he adds.

Pesole says one area of concern is the recent deterioration in U.S.-China relations (following an incident involving a balloon).

"But Australia still seems on track to easing trade tensions with Beijing, and the room for further hawkish repricing in RBA rate expectations means that 0.75 in AUD/USD could be reached during a soft-USD environment in 2Q22," says Pesole.

China's commerce minister Wang Wentao said talks held on Monday with Australian counterpart Don Farrell were a key step toward bringing bilateral economic and trade ties back on track, with relations improving after being strained in recent years.

The virtual meeting "represents another important step in the stabilisation of Australia's relations with China," Farrell said after the first talks between the trade ministers of the two countries since 2019.

The improvement in relations has been a key source of impetus for Aussie Dollar upside over recent weeks.