RBA Preview: AUD Rate Decision will be a Close Call

Last updated 4/6/2009 1:38 PM ET (GMT -5) 0 Comments - Add your comment

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Kathy Lien

Director of Currency Research, GFT

Over the past week, the Australian dollar staged an impressive rally as upside surprises in economic data fueled expectations that interest rates will be left unchanged for the second time in a row. Since March 10th, the Australian dollar has appreciated from a low of 0.6340 to an intraday high of 0.7228 on Friday. The Reserve Bank of Australia has a monetary policy meeting on Monday evening NY time, Tuesday morning in Sydney and the outcome of the meeting will determine whether the Australian dollar is able to sustain its gains. Currently, the market expects the RBA to leave interest rates unchanged, but some people believe that the RBA could cut rates by as much as 50bp, which means the upcoming rate decision, could be a close one. Although, leaving interest rates unchanged has become a common practice of many central banks these days, what sets Australia apart is that interest rates are not at zero, leaving the RBA with room to ease. At 3.25 percent, the country currently has the highest interest rate amongst developed countries. In March, the RBA left interest rates unchanged for the first time in 7 months. At the time, central bank Governor Glenn Stevens said that the combination of aggressive government spending and extremely low interest rates would provide significant support for the economy. The country has been more resilient than all of its peers and is the only one to remain recession free. Going into the rate decision, we have seen broad based improvements in economic data.

Why the RBA Could Leave Interest Rates Unchange d

Cutting their target rate to a nearly half-century low, the RBA has introduced a massive amount of liquidity for the financial markets. The RBA has cut rates by 400bp since September, which is large even in comparison to the Federal Reserve and the Bank of England. In addition to the aggressive monetary stimulus, fiscal stimulus has also provided the economy with major support. In fact, the Australian government is planning to announce a third stimulus package next month. This may be enough reason for the bank to wait and see how the economy responds before overdoing rate cuts which can have the risk of triggering runaway inflation once the economy picks up. Recent economic data has provided the RBA with cause for optimism. Last week, the trade balance, building approvals, manufacturing and service sector PMI surprised to the upside. The country is still seeing positive job growth albeit marginally. Overall, the Australian economy is faring well compared to its peers and if the global economy is stabilizing as the equity market rally suggests, then the benefits for the Australia will be compounded.

Why the RBA Could Cut Interest Rate s

However not all pieces of economic data have been strong. Retail sales plunged 2 percent in the month of February, validating RBA Deputy Governor Ric Battelino’s forecast that GDP could turn negative this year. The slowdown in the global economy has taken a big toll on Australia and unfortunately the country has been struggling to maintain positive growth. Only time will tell if the fiscal and monetary stimulus will be enough to keep growth afloat. A rate cut would help to boost confidence and lay the groundwork for a recovery. Unemployment is at a 4 year high and restoring confidence is crucial. As you can see, the arguments are compelling for both leaving interest rates unchanged and cutting rates. It is clear that the fiscal and monetary efforts by the Australian government have provide support for the economy but if the economy is expected to worsen like the Deputy Governor predicts, then more stimulus may be necessary.

The following table illustrates the changes in the Australian data since the last monetary policy meeting and its impact on the economy.

How Could the Australian Dollar React to the Rate Decisio n

It is obvious that in the event that the RBA decides to leave interest rates unchanged once again, it would be significantly positive for the Australian dollar and drive the currency towards 75 cents against the U.S. dollar. If the RBA cuts rates on other hand, it would send the AUD/USD plummeting towards 70 cents. However the currency pair that may see the more lasting reaction to an unchanged rate decision from the RBA could be EUR/AUD. The rationale is that the European Central Bank basically told us last week that interest rates will continue to fall and there is a strong chance that they could announce unconventional monetary policy measures like Quantitative Easing at their next meeting. EUR/AUD is sitting above very important technical levels and should the RBA decision drive the currency pair below its support at 1.8606, we could see sharper losses that extend towards 1.80. Drawing a Fibonacci retracement from June 2008 lows to the October high gives us a 50% retracement at 1.8606. Not only is this level a significant retracement level, but it also coincides with the 200 day SMA and prior lows.

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About The Author

Kathy Lien began her FX trading career 10 years ago at J.P. Morgan Chase. After graduating New York University’s Leonard Stern School of Business at the age of 18, Kathy joined the bank's interbank FX trading desk and eventually moved to the cross markets proprietary trading desk. In the interbank market, her ability to create solid fundamental and technical analysis from the myriad of information on the market helped her trade forex spot and options. Her experience eventually led her to be chief strategist at Daily FX where she worked until she joined GFT in 2008.

With her knowledge of forex, as well as her experience trading other products, such as interest rate derivates, bonds, equities, and futures, Lien has built a reputation as an international currency analyst. She is frequently quoted on CNBC, Bloomberg, Fox Business and Reuters. Lien has also written for publications like Active Trader, Futures, and SFO magazine. She is the author of the newly updated Day Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, and the co-author of Millionaire Traders: How Everyday People Are Beating Wall Street at Its Own Game with Boris Schlossberg.

To buy Kathy’s newly updated Day Trading and Swing Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, click here.