The Australian dollar fell after the RBA hiked 0.25%, as expected. Where is AUD/USD headed?

Australian Dollar, AUD/USD, RBA, CPI, PPI, ASX 200, Fed, Bank of England – Talking Points

• RBA rose 0.25% for second consecutive month to 2.85%
• AUD/USD fell on the news, as there were weak hopes for a 0.50% increase.
• The RBA seems comfortable with smaller hikes, despite the uncomfortable CPI

The Australian dollar dropped after the Reserve Bank of Australia (RBA) raised its target cash rate by 25 basis points (bps), as expected, to 2.85% from 2.60%.

The currency rallied in the decision amid easing US dollar. It is still in green at the time of going to press.

In the accompanying Monetary Policy Statement (MPS), the bank changed its view of where inflation would peak, raising it to 8% from 7.75%. Despite the CPI adjustment northward, they still expect inflation to fall sharply in 2023.

Today’s decision follows last week’s stunning third-quarter CPI reading of 7.3% year-on-year by the end of October, beating forecasts of 7.0% and 6.1% previously.

The RBA has a binding target of 2% on average over the cycle. The CPI has fallen since the start of the pandemic, but has been above 3% since the second quarter of 2021.

The preferred measure of inflation is the so-called “truncated average,” which many economists consider the best measure of core inflation. Unfortunately for the RBA, it also accelerated to 6.1% year-on-year in the third quarter, well above expectations of 5.5% and 4.9% previously.

Retail sales were released yesterday and beat expectations again in September, coming in at 0.6% from last month, the same as August but above forecasts for 0.5%.

The problematic outlook for price pressures is compounded by the CPI moving higher again in the third quarter. At the end of October, it amounted to 6.4% on an annual basis, which exceeds the previous figure of 5.6%.

​​​​​​While there is a lot of talk about the lead/lag effects of monetary tightening, PPI also takes some time to run out and reach CPI.

Companies facing higher costs essentially have two options. They can absorb rising costs of doing business and see margins squeezed, or they can pass on their higher costs to consumers.

The last option represents the risk of CPI growth and strengthening of inflationary expectations.

When the CPI is above the CPI, companies that are able to pass on rising costs are more likely to do so, but this creates problems for the central bank trying to contain the CPI. If the CPI continues to accelerate, it’s hard not to see either a higher CPI or lower earnings for companies ASX 200.

Implications for AUD/USD remain somewhat opaque with the Federal Reserve holding them Federal Open Market Committee (FOMC) meeting on Wednesday to decide on the extent of their increase to the target rate.

The market is pricing in 75bps as they try to catch their volatile CPI, and any perceived reversal to their aggressive hawkish stance will be in focus. The implications of such a move would have significant implications for the US dollar, and the Aussie would likely be caught up to some degree by such a move.

Later today, RBA Governor Philip Lowe will address a business forum in Hobart at 08:20 GMT and his comments will be closely watched for future rate changes.

You can read the full RBA statement here.

AUD/USD CHART

The chart is created in TradingView

— Posted by Daniel McCarthy, DailyFX.com Strategist

To contact Daniel, use the comment section below or @DanMcCathyFX on Twitter