Australian Dollar Outperforms as RBA Won't Rule Out Further Rate Hikes

Above: RBA Governor Bullock. Image: Pound Sterling Live, still: CBA News.

The Australian Dollar was the best-performing major currency in the hours following the Reserve Bank of Australia's confirmation that it stood ready to raise interest rates again if needed.

The RBA left interest rates unchanged but opted to keep guidance referencing the potential for further interest rate rises, which sets it apart from other central banks that have recently dropped such guidance.

"The path of interest rates that will best ensure that inflation returns to target in a reasonable timeframe will depend upon the data and the evolving assessment of risks, and a further increase in interest rates cannot be ruled out," said the RBA.

Markets always expected interest rates to remain unchanged but saw the potential for the RBA to drop the reference to the need for further rate hikes.

The inclusion of such reference in the February statement makes this latest guidance something of a 'hawkish' surprise for financial markets.

Confirming this outcome is the outperformance of the Aussie Dollar on the day:

Above: AUD was the best-performing major currency on February 06. Track the AUD with your own custom rate alerts. Set Up Here

"The Statement maintains a hawkish tilt," says Gareth Aird, an economist at Commonwealth Bank of Australia. "It will take more than just weak economic growth for the RBA to entertain the idea of policy easing."

The outcome is a firming in Aussie bond yields relative to elsewhere, which has a knock-on effect on currency markets and reflects in a firmer AUD.

The Pound to Australian Dollar exchange rate extended its recent pullback to quote at 1.9280 at the time of writing, the Euro to Australian Dollar is lower at 1.6517. The Australian to U.S. Dollar exchange rate is half a per cent higher on the day at 0.6517.

"The AUD climbed as the market trimmed its rate-cut pricing after the RBA meeting," says Daragh Maher, a currency strategist at HSBC.

Despite the initial gains, Maher interprets the tone of Governor Bullock's press conference as reflecting a desire for maximised optionality and not a tightening bias.

"Moreover, our medium-term outlook still remains bearish, and we prefer to sell the AUD," says Maher.

To be sure, the RBA has softened its language on the need for further rate hikes when compared to December's more forthright statement.

But, "it is still a little on the hawkish side relative to most expectations; the Board were not about to do a complete 180-degree turn in the space of three months," points out Luci Ellis, Chief Economist at Westpac.

The RBA says inflation is still too high, particularly service sector inflation, and that "the level of demand is still robust and is assessed to be above the economy's capacity to supply goods and services, thereby creating inflationary pressures."

The RBA's latest forecasts nevertheless show a downgrade to 2025's inflation profile, accompanied by lower GDP growth projections.

Westpac says it does not expect the RBA to deliver further interest rate hikes, although rate cuts are still some way off.

CBA says the unemployment rate will likely need to rise a little more quickly than the RBA anticipates, and inflation will need to fall a little faster.

"We expect both of those outcomes to transpire, and we remain comfortable with our base case," says Aird, expecting the RBA to commence an easing cycle in September 2024.