The Reserve Bank of Australia will make an announcement on monetary policy on Tuesday at 0330 GMT and it is certain that policymakers will choose to keep interest rates at record lows for the 26th consecutive month. Some discomfort however is expected regarding recent weakness in economic data, while escalated global risks could be another reason to hold policy accommodative for now.
Australian consumer prices grew by 1.9% year-on-year in the third quarter, in line with forecasts but below the 2.1% mark printed in Q2. The core measures however surprised analysts, with the trimmed mean and the weighed median CPIs arriving lower on average at 1.75% compared to the 1.9% forecast, an indication that the RBA will more likely fail to achieve its 2-3.0% inflation goal for another year. With the final quarter underway, questions are also arising about whether the core inflation will remain steady at 1.75% for the second year as the Bank predicts. Another disappointing CPI report in Q4 for instance could shed more light about whether “the next move in rates should be up”.
While the RBA has already flagged that interest rates are not likely to change from a record low of 1.5% until late 2019, discouraging inflation prints ensured that the central bank will keep its guidance on Tuesday. But even if the readings were about to improve, a subdued wage growth would probably hold the RBA’s hands tight as policymakers are relying on wage dynamics to achieve their inflation goal. The latest evidence though showed that despite wages rising a bit faster in the second quarter as expected, the speed was still among record lows, a sign that consumers are not yet in a position to pay higher borrowing costs at a time when burdening debt obligations are barely met.
Besides the above, economic developments in China, a top buyer of Australian exports, is another reason to avoid rate hikes at the moment. In the three months to September, GDP growth in China slowed down for the third straight quarter, reaching the weakest pace in nine years, with investors speculating that US import tariffs on Chinese exports have started to bite activities in the world’s second biggest economy. Manufacturing PMIs were also not so encouraging over the past few months, indicating that Chinese factories are struggling to maintain healthy growth. This in return raised worries that if conditions deteriorate even further, China might turn more careful regarding its spending on foreign products, bringing headwinds to Australian exporters. Yet, latest trade data showed that Australian exports to China reached a new record high in September, whilst should Beijing materialize its proposed counter measures to avoid any disruption from tariffs, the damage on the Australian economy might appear minimal. Still, it remains to be seen whether the US is willing to relax its trade restrictions at the G20 meeting in Argentina later this month.
In the FX markets, aussie/dollar stretched its downtrend started in February towards 2 ½ -year lows in October, making Australian goods more competitive abroad. The pair could lose more if the RBA holds borrowing costs steady on Tuesday but uses a dovish tone to refer to inflation and/or trade-related risks. In such a case, bears could drive the price down to 0.7178, which the market was unable to break on Friday. A move lower and below the 20-period moving average currently at 0.7173, could bring the October 17 high of 0.7159 into view, while steeper declines may also reach the 0.7100 psychological level. Support around 0.7058 could be another barrier to downside movements.
Alternatively, remarks highlighting optimism that a tighter labor market may lift wages and thus price growth in coming months, could help the aussie to rally towards the five-week high of 0.7258 marked on Friday. Even higher, all eyes will shift to the 0.7300 round-level, last seen in September.
Later in the week, the outcome of the US midterm elections due on Wednesday may disrupt the market ahead of the RBA’s Monetary Policy Statement on Friday which will include new quarterly economic projections.
