Australian CPI expected to rise

The Australian dollar has edged lower today. AUD/USD is trading at 0.6937, down 0.15% on the day.

Markets brace for higher CPI

Australia releases second-quarter CPI on Wednesday, with the markets expecting a sharp acceleration in inflation,  which could wake up the sleepy Australian dollar. Headline inflation is expected to jump to 6.2% YoY, up from 5.1% in Q1. Trimmed Mean CPI, which is core inflation, is also expected to rise sharply, up to 4.7% from 3.7%.

If inflation rises steeply as expected, what would this mean for the RBA? The markets have priced in a 50bp increase at next week’s meeting, which would bring the cash rate to 1.85%. At the same time, a 75bp supersize hike cannot be discounted.

The key question of “how much, how fast” will the RBA increase rates depends on the strength of the economy and how hot inflation is running. The RBA has designated inflation as enemy number one, but wants to lower economic growth as a “soft landing” and avoid a recession if possible. A strong and resilient economy gives the RBA more leeway to tighten ‘higher and faster’ – perhaps even by 0.75% at the August meeting if today’s inflation report is higher than expected.

The RBA’s forward guidance is that more rate hikes are coming. The minutes of the July meeting stated that policymakers discussed the neutral rate (which is neither expansionary nor contractionary) and the 1.35% cash rate was “well below” that. Governor Lowe has often quoted 2.5% as around neutral, leaving little doubt that the RBA plans more hikes in the second half of the year.

After the Australian inflation report, attention will shift to the Federal Reserve, which holds its meeting on Wednesday. A massive 100bp hike is a possibility, but the greatest likelihood is a 75bp move. CME’s Fed Watch has pegged a 75bp increase at 75% and a 100bp hike at 25%. If, as expected, the Fed delivers a second-straight 75bp move, it will be interesting to see if the US dollar gains any ground or will the reaction be muted. A 100bp hike would surprise the markets and likely send the US dollar higher.

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AUD/USD Technical

• There is resistance at 0.7005 and 0.7085
• 0.6897 is providing support, followed by 0.6817

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