Key considerations for Tuesday’s RBA meeting

The main consideration at this Tuesday’s Reserve Bank of Australia (RBA) meeting is whether the central bank will acknowledge the rampant strength in the AUD and alter their language around the currency.

Source: Bloomberg

This view is premised on the fact that since the February meeting, AUD/USD has rallied 7.5%, while the trade-weighted AUD has gained 5%. Importantly the trade-weighted AUD is now some 4% above the levels modelled in the February Statement on Monetary Policy (SoMP). That, in itself, puts downside risks in their year-end inflation forecast of 2-3% (both for core and headline inflation).

However, we must remember that Brent prices are also 14% above their February forecast, while iron ore and steel prices are over 20% higher than the February meeting. If the AUD had rallied without the upside also seen in the key terms of trade, then the RBA would certainly be looking to alter its language on the currency. But that is not the case, and the rally into $0.7700 has been backed by an improvement in its key revenue drivers.

What would a change in language look like?

In August 2015, the Reserve Bank altered its language from a ‘further deprecation seems both likely and necessary’ to ‘the exchange rate has been adjusting to the evolving economic outlook’. One suspects if they genuinely feel their inflation forecasts are under threat then they would re-adopt the prior stance of ‘likely and necessary’. Given the market is currently pricing the probability of a June rate cut at 30%, if we do see a change of a language, one suspects we will see traders price in a much higher probability and AUD/USD will like go towards $0.7500.

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