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Australian Dollar is Outperforming after Inflation Beat

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Australia's inflation rate is rising at its fastest pace since 2009 shows new data from the ABS, offering a boost to the Australian Dollar.

"AUD is outperforming after strong inflation data," says Adam Cole, Chief Currency Strategist at RBC Capital Markets.

CPI inflation rose 2.1% quarter-on-quarter in the first quarter, ahead of the 1.7% figure the market was expecting.

It rose 5.1% year-on-year in the first quarter, beating expectations for 4.6%.

Australian CPI inflation

Image: ABS.

The Trimmed Mean CPI inflation rate rose 1.4% Q-o-Q, beating expectations for 1.2%: this is significant as it is the Reserve Bank of Australia's preferred measure.

"Inflation has become increasingly broad based," says Cole, "the case to begin policy normalization sooner rather than later has strengthened."

RBC Capital's economists have brought forward their expectations of when the Reserve Bank of Australia (RBA) will raise interest rates from June and July (hikes of 15bp and 25bp), to May and June.

Money market pricing shows investors are betting on over 230 hikes from the RBA in 2022, meaning on the Federal Reserve is expected to raise interest rates further and faster.

Interest rate expectations tend to be an important driver of currency movements and the rising of RBA rate hike expectations is supportive of the Australian Dollar.

The Pound to Australian Dollar exchange rate fell back to 1.7524 in the wake of the inflation data, the Australian Dollar to U.S. Dollar exchange rate rose two-thirds of a percent to trade at 0.7186.

"Interest rate differentials are an important driver of the AUD/USD and are likely to become less supportive of the AUD over H2 2022," says strategist Kristina Clifton at Commonwealth Bank of Australia.

CBA expects the RBA to 'normalise' the cash rate beginning in June and they see a peak rate at the RBA of 1.25%, versus financial market pricing of a peak near 3.5%.

If CBA are correct the market is massively overestimating the number of hikes that will come from the RBA, which could spell disappointment for Australian Dollar bulls.

"We expect some market pricing to be unwound once the RBA begin to tighten and we see the impacts of higher interest rates flowing through to the economy," says Clifton.

Overnight moves in AUD

Above: Overnight moves in AUD against GBP (top) and USD (bottom).

However CBA don’t expect an unwinding in RBA pricing to prompt a significant fall in the Australian Dollar because commodity prices are expected to stay high through 2022.

CBA analysts estimate the Australian Dollar is also "quite undervalued" which limits any downward pressure on this currency pair.

They forecast the AUD/USD exchange rate to reach a peak of 0.82 in March 2023.