Aussie slips as inflation falls, Fed expected to hike

• Australian inflation falls more than expected
• Fed widely expected to raise rates by 0.25% on Wednesday

The Australian dollar is in negative territory on Wednesday. In the European session, AUD/USD is trading at 0.6758, down 0.49%. The Aussie fell as much as 0.90% earlier in the day but has recovered some of these losses.

Australian inflation declines more than expected

Australian inflation declined more than expected in the second quarter, sending the Australian dollar lower as pressure has eased on the Reserve Bank of Australia to raise interest rates.

Headline inflation rose 6% y/y in the second quarter, down from 7% in the first quarter and below the consensus estimate of 6.2%. June monthly inflation dipped to 5.4% y/y as expected, below the May reading of 5.5%. The RBA Trimmed Mean CPI, a key gauge of core inflation, fell to 5.9% y/y in Q2, down from 6.6% in Q1 and just below the consensus of 6.0%.

The positive inflation data was spoiled somewhat by services inflation, which accelerated to 6.3% in the second quarter, its highest level since 2001. A key factor driving up services inflation was higher rents, according to the Australian Bureau of Statistics.

The RBA meets on August 1^st and investors have lowered the odds of a rate hike following the positive inflation report. The probability of a rate hike has fallen to 31%, down from 41% prior to the inflation report, according to the ASX RBA rate hike tracker. The RBA will release updated economic forecasts at the meeting, and investors will be especially interested in the inflation projections.

What happens after August? An extended pause is the RBA’s preferred move, but that will likely require inflation to continue heading lower toward the 2% target. Otherwise, the RBA will still have work to do on the inflation front and would likely have to continue tightening rates.

Markets await Fed hike

The Federal Reserve is widely expected to raise rates at Wednesday’s meeting, and investors have priced a hike at close to 100%. This would bring the benchmark rate to a range of 5.25% – 5.50%. Investors expect a pause in September but the Fed has signalled another rate hike after Wednesday’s meeting. The Fed’s rate policy will depend to a large extent on inflation levels and the strength of the labour market.

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AUD/USD Technical

• AUD/USD is testing support at 0.6767. Below, there is support at 0.6687
• There is resistance at 0.6811 and 0.6891

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