The Australian dollar (AUD) depreciated against the US dollar (USD) following the RBA’s policy decision to keep interest rates at 4.35% for the fourth meeting in a row as was widely expected. On the other hand, the US dollar remained subdued due to expectations of Fed rate cuts and improved risk appetite.
RBA and inflation risks
The Australian dollar weakened on Tuesday after the Reserve Bank of Australia (RBA) decided to keep its interest rate unchanged at 4.35%. However, markets anticipate that the RBA might become more hawkish after last week’s better-than-expected inflation data. Australian inflation continued to decelerate for the fifth quarter in a row, despite surpassing initial forecasts. Additionally, the monthly CPI indicator accelerated in March, despite market expectations of stagnation.
Following May’s monetary policy announcement, the Reserve Bank of Australia (RBA) Governor Michele Bullock addressed a press conference and highlighted the importance of remaining cautious of inflation risks. The RBA clarified that it has adopted a more long-term viewpoint and was confident that the current interest rates will help move inflation back towards its target range of 2-3% in the second half of 2025, and to the midpoint in 2026. Despite some fluctuations in the data, the bank stressed that it was focusing on the bigger picture, while remaining vigilant. Governor Bullock said: While “data are proving bumpy, we are taking a longer view.” “We want to keep employment growing, but there are risks.” She recognised that “we have to be very watchful” and that “It will be more costly to end up with higher inflation than lower inflation.” She also stated that it won’t be necessary to tighten again.
According to forecasts by analysts at Commonwealth Bank and Westpac, the RBA’s interest rate will fall to 3.10% by December 2025.
Federal Reserve and rate cut expectations
The US Dollar Index (DXY), which calculates the performance of the US dollar against six major currencies, continued to face pressure after Friday’s release of softer US labour data. On Friday, Nonfarm Payrolls showed that the US economy added 175,000 jobs in April, which was lower than the estimated 243,000 that was expected and marked a significant slowdown from March’s 315,000 added jobs. The report rekindled hopes for potential Fed interest rate cuts in 2024.
According to Bloomberg, Richmond Federal Reserve (Fed) President Thomas Barkin said on Monday that higher interest rates would weigh on US economic growth. However, elevated interest rates have eased inflationary pressures which have dropped closer to the Fed’s 2% target. Barkin also explained that the strong labour market has provided the Federal Reserve with the opportunity to ensure that inflation has declined consistently before considering any changes to borrowing costs. At the same time, he warned of the risks of higher inflation in the housing and services sectors which will keep prices elevated.
Chinese data could lift the AUD
Investors who closely follow the AUD/USD pair will also focus on China’s economy and releases due to the close trading relationship between China and Australia (China is Australia’s largest trading partner). In particular, China’s Caixin Services Purchasing Managers’ Index (PMI) for April dropped slightly to 52.5 from 52.7 in March but was in line with market expectations. This is the 16th consecutive month of expansion in services activity and the positive trend could boost the Australian market, and consequently the AUD, given Australia’s role as one of the largest exporters to China.
What to watch out for?
If you are exchanging the AUD, you should focus on the Reserve Bank of Australia (RBA) and updates on interest rates. A key driver is also the price of Australia’s biggest export, Iron Ore. As mentioned, updates on the health of the Chinese economy are also a key factor along with Australia’s inflation and Trade Balance. Market sentiment is also influential, and the AUD tends to strengthen when sentiment is risk-on.