Aussie yawns after inflation surges

The Australian dollar is flat on Tuesday, trading quietly at 0.7140 in the European session.

Q4 inflation higher than expected

Inflation remains on the move, as fourth-quarter CPI beat expectations. CPI climbed 1.3% q/q (1.0% exp.), up from 0.8% in Q2. On an annualized basis, CPI jumped 3.5% (3.2% exp.), up from 3.0% in Q2. The drivers behind the rise in inflation were higher fuel prices and the cost of new homes, as the construction sector continues to grapple with a shortage of building materials coupled with strong demand.

With annualized inflation running at a 3.5% clip, above the RBA’s target band of 2%-3%, the key question facing the markets is how will the RBA respond? Unemployment has fallen faster and inflation has climbed higher at a faster pace than the RBA anticipated, but this does not mean that a rate hike is around the corner. RBA Governor Philip Lowe has repeatedly stated that he won’t raise rates until unemployment has fallen to 4% and wage growth rises to 3%. Unemployment is close to that requirement, falling to 4.2% in December, but wage growth is well below target, at 2.2%.

Central bankers like to rely on the argument that high inflation without a rise in wage growth is not sustainable, which is why I would urge market participants not to assume that the RBA will shift policy even if inflation keeps climbing – the bank may well decide to hold off on a rate hike until wage growth is at or close to 3%, which is not expected to occur prior to 2023.

Of course, there is always the possibility that Governor Lowe will change course and become more aggressive due to market pressure and the rise in inflation, as was the case with the Federal Reserve which has become more hawkish over the past few months. The strong CPI reading is also significant in that it lends further support to expectations that the RBA will wrap up its bond-buying scheme at the February meeting.

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AUD/USD Technical

• AUD/USD is putting pressure on support at 0.7138. Close by, there is support at 0.7101, protecting the round number of 0.7100
• There is resistance at 0.7245 and 0.7315

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