Australian Dollar Slips Lower as RBA Sits on Hands for 22nd Month Running; "Fade the AUD" say Strategists

-AUD dips lower after RBA sits on hands for 22 month running.

-Cash rate held at 1.5% as RBA waits for wage growth and inflation.

-TD Securities abandons Nov 18 rate hike call, says "fade" the AUD.

© Goroden Kkoff, Adobe Stock

The Australian Dollar slipped Tuesday after the Reserve Bank of Australia held its interest rate steady at its current record low, citing low inflation and weak household earnings growth, which are expected to persist for a while to come. 

This leaves Aussie interest rates at 1.5% and the Reserve Bank watching and waiting for signs of wage pressures building in the labour market, which it hopes will drive higher consumer spending and support inflation at a level that is within the 2% to 3% target band. 

There weren't any economists who had expected a change in rates and few saw the accompanying statement revealing anything new about the bank's policy outlook in the first place, although that didn't prevent traders from offering the Aussie Dollar lower during the morning session Tuesday. 

"The Australian dollar has given back some of yesterday’s strong gains after it broke back above the 0.7600-level against the US dollar. The Australian dollar has been gradually rebounding for almost a month now supported in part by the stronger than expected economic data flow from China," says Lee Hardman, a currency analyst at MUFG. "The external environment continues to be the main driver of the Australian dollar rather than domestic developments. That dynamic appears unlikely to change any time soon after the RBA continued to signal that they are in no immediate rush to begin raising rates."

The AUD/USD rate was quoted 0.27% lower at 0.7629 during morning trading Tuesday while the Pound-to-Australian-Dollar rate was 0.26% higher at 1.7444. The Aussie was quoted lower against all other developed world currencies.

"The next move in interest rates is likely to be higher and we have an interest rate rise in our forecasts for February 2019," says Kristina Clifton, a senior economists at Commonwealth Bank of Australia. "However, developments this year, including a tightening in lending standards, a soft patch in the global economy, and higher short term interest rates mean that the RBA is likely to be even more patient when thinking about the timing of the first rate hike."

Tuesday's RBA statement comes hard on the heels of data showing Australian retail sales rising faster than was expected during the April month, and ahead of the initial estimate of first-quarter GDP growth, which is due for release at 02:30 am London time Wednesday.

Australian retail sales rose by 0.4% during April when markets had been looking for just a 0.3% gain. Some strategists have said the stronger retail spending growth means the Wednesday GDP data is liable to surprise on the upside. 

"We recommend fading any pop higher in AUD or short bond yields in reaction to the headlines. The RBA already expects GDP growth to print above 3%/y, so will not necessarily be a surprise to the Bank. We also know that RBA Governor Lowe is looking for wages growth closer to 3%/y, hence the endless patience in the meantime," says Annette Beacher, chief Asia Pacific macro strategist at TD Securities, speaking of the GDP data. 

For the Australian Dollar to make a sustainable advance against other developed world currencies, Aussie wages and inflation will need to rise at a sufficient enough pace for the RBA to feel comfortable raising interest rates. But judging by most forecasts, this is unlikely to happen for a while yet.

Above: AUD/USD rate shown at daily intervals.

Australian inflation has been beneath the lower bound of the Reserve Bank of Australia's 2% to 3% inflation target ever since late 2014 and due to recent weak economic data, is only expected to rise gradually into the target band during the year ahead. As a result the RBA will have little reason to contemplate raising its interest rate for a while yet.

"Most data outcomes since the May Statement on Monetary Policy - Q1 Real Retail Sales, Home loan data, Wages, Capex and Consumer Confidence - have disappointed and the market has accordingly shaved the probability of a RBA hike by year end to just 5%," says Beacher, in a separate and earlier note to clients. 

The run of negative Australian economic data in May and through much of 2018 has only served to darken the inflation outlook which is bad news for the Australian Dollar because policymakers can only raise rates when rising inflation commands a monetary policy response.

This creates a headache for the Aussie Dollar, particularly as the Federal Reserve, Bank of Canada, Bank of England and European Central Bank are all expected to make currency supportive tweaks to their monetary policies over the next year - which has seen the Australian currency forced onto the back foot relative to its developed world peers so far in 2018.

Divergence between monetary policies down under and those elsewhere in the world mean interest rate differentials are increasingly disadvantaging the Australian currency, which has typically benefitted from the support of interest rates that were traditionally higher than those of other developed markets.

It is this trend in interest rate differentials that drove the Aussie close to a 12-month low against the US greenback back in May and a near 2-year low against Pound Sterling.

Above: Pound-to-Aussie rate shown at daily intervals.

"The sound of rate hike capitulation has been deafening, and we reluctantly add to the noise. While we retain our 'glass half full' stance on the economy, the data flow has been insufficient to move the needle for the RBA, and a rate hike by year end is difficult to deliver," Beacher adds.

Beacher and the TD team have abandoned their earlier forecast that the Australian central bank would raise its interest rate in November 2018 and now predict the RBA will wait until the middle of 2019 before lifting the cash rate from its current record low.

"Our base case looks for two rate hikes in 2019, May and November, for a cash rate of 2% by end-2019. Only significant upside surprises to core CPI and wages could bring forward this timetable at this juncture," the strategist writes, in a recent briefing.

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