Article / 27 July 2016 at 2:35 GMT

Australia’s inflation beats forecasts but rate cut still likely

Managing Director / Technical Research Limited
New Zealand
  • AUDUSD rose after Australia’s June CPI data came in, before giving up gains
  • The trend suggests an extended period of sub-par inflation is setting in
  • A rate cut by the RBA to 1.5% next week is still likely
  • RBNZ will likely follow suit if Australia cuts, or the exchange rate will move higher

By Max McKegg

AUDUSD jumped from 0.7510 to 0.7565 earlier today after Australia’s June quarter inflation numbers came in slightly better than expected. However, it soon gave up most of the knee-jerk gains as traders came to the conclusion the result is unlikely to deter the Reserve Bank of Australia from cutting its policy rate to 1.5% next Tuesday. NZDUSD, usually tied to the hip of the Aussie, declined a touch.
Core inflation came in at 1.7% year on year versus 1.5% expected.

 Beating expectations ... Australia's CPI came in slightly better than expected but a rate cut next week is still on the cards. Photo: iStock
The RBA has been quite successful in holding inflation in its narrow 2-3% target range for many years, with only short over or undershoots, but the trend suggests a more extended period of sub-par inflation is setting in.

 Source: Reserve Bank of Australia
From a trading perspective, AUDUSD appeared to be asymmetric heading into the inflation update. Money markets were already pricing in a 70% probability the RBA would deliver a rate cut next week. Hence the downside potential in AUDUSD looked to be limited if the numbers came in at, or even slightly below, expectations. 

In contrast, better-than-expected numbers would throw a cat among the pigeons and trigger a sharp short-covering rally on the basis that the RBA might be emboldened to sit this one out. In the event we got a result somewhere in between.
Yield convergence is guiding FX markets
The RBA and its counterpart in New Zealand have for many months assumed that jawboning about “record low interest rates” would depress their exchange rates. But record low rates Down Under still represent relatively high rates in a global context, as illustrated in the graphic of world bond rates below. 

Yield convergence has become the name of the game, and countries like Australia and New Zealand who have had their heads in the sand now find themselves with overvalued exchange rates – losers in a currency war they’ve only belatedly realised they were part of.

Source: ANZ Bank 

Rate cut looks a done deal in New Zealand
The only economic data point out of New Zealand this week is the ANZ Business Confidence survey on Friday. The economy appears to be ticking over nicely, growing around 3% per annum. So confidence should be holding up. 

Perhaps the most significant part of the survey will be inflation expectations. The Reserve Bank of New Zealand is in a similar, but more acute, bind than its Australian counterpart. Last week’s inflation update, and subsequent comments from the bank, have all but locked in a 25 basis point cut to the Official Cash Rate on August 11, taking it down to another record low of 2.00%. 

But, as this chart shows, the Overnight Index Swap curve bottoms out around 1.68%, implying two cuts are on the cards. The RBNZ’s interest-rate projection, also due on August 11, will probably meet the market, although some economists, in this case those from Westpac, think the bank might want to keep something up its sleeve and project 2.00% as a base.
The RBNZ has the advantage of being able to wait and see what the RBA does next Tuesday, but with NZDAUD having the highest weighting in the Trade Weighted Index, it will have no choice but to follow suit if Australia cuts, or the exchange rate will move higher.
Source: Westpac
With the Australian inflation update now out of the way, AUDUSD and NZDUSD traders can turn their attention to the US Federal Reserve’s post-meeting statement, due early tomorrow morning local time. Dragged down by German and Japanese markets, real rates in the US are now negative out to 10 years (using the core CPI at 2.2% annual as the measuring point) at the same time as the economic data is beating expectations, as illustrated by the Citigroup Economic Surprise Index in the chart below.
In such circumstances the Fed may take the opportunity this week to guide the markets into tightening conditions a touch, while being careful not to give traders any excuse to spark a US dollar rally. So neither the RBA nor RBNZ can expect much assistance from the Fed in pushing their currencies down. 


Source: Bank of New Zealand

– Edited by Gayle Bryant

Max McKegg is managing director of Technical Research Limited. If you would like an email notice each time Max posts a trade or article then click here or post your comment below to engage with Saxo Bank's social trading platform. 
27 July
brian1983 brian1983
sell nzd or aud usd.. which is better.

nzd usd rate cut looks like a done deal n retest 65-67 cents after the cut. aud not too sure will cut. but problem is rbnz is one week away than rba
27 July
Patto Patto
There is some talk that if the RBA cuts by 25 bp to 1.5% next Tuesday, the RBNZ will cut by 50 bp on Aug 11. That's not priced in yet - but seems to be the only way they can get NZD down (unless they intervene that is .............)
27 July
Max McKegg Max McKegg
Both have Downside Risk, I'm already Short NZDUSD
27 July
Max McKegg Max McKegg
just posted Analysis on NZDUSD Patto
27 July
brian1983 brian1983
I am also shrot on nzd usd at 0.70496 but it seems to move a bit slower than audusd
27 July
Jamesawann Jamesawann
Limit order not hit at .7576 but shorted at lower aud/usd
27 July
brian1983 brian1983
jus check. still holding onto aud n nzd short?
28 July
Max McKegg Max McKegg
covered yesterday pre Fed ...


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