Australia will report inflation numbers for the first quarter on Wednesday at 0130 GMT, providing investors with a vital piece of information ahead of the Reserve Bank of Australia’s policy meeting on May 7. With rate cut odds easing slightly following some upbeat economic indicators out of China recently, a weaker-than-expected price reading on Wednesday could lead to some of these bullish bets being pared back. Hence, the Australian dollar will be sensitive to any surprises in the data.
Inflation in Australia has barely stood inside the RBA’s 2-3% target band since the end of 2014 and likely weakened substantially during the first three months of the year. The consumer price index (CPI) is forecast to have risen by 1.5% year-on-year in the first quarter, slowing from 1.8% in the prior quarter. On a quarterly basis, CPI is expected to have increased by 0.2%, which would be the lowest since the second quarter of 2017.
Underlying measures of inflation have also been running below the RBA’s target band for much of the past year, raising doubts about the Bank’s game plan that a tightening labour market would eventually put upward pressure on prices. Core CPI, which excludes volatile items, edged up to 1.6% in Q4 2018 after slumping to 1.2% in the previous quarter, while the weighted median and trimmed mean printed at 1.7% and 1.8%, respectively.
But as inflation shows no sign of moving towards the RBA’s desired range, policymakers appear to be shifting their stance, with the central bank’s April policy meeting minutes giving the strongest hint yet that the next move in interest rates could be down. In the minutes, the RBA clearly laid out the conditions under which a rate cut would be “appropriate” where inflation is not moving any higher and unemployment is trending up.
While this may provide investors with clarity on where the RBA stands, the outlook on the economy is not so clear. Unemployment in Australia is hovering around 5%, near 8-year lows, and employment continues to rise at healthy levels. However, wage growth remains muted at 2.3% y/y and only faster economic expansion would help push wage pressures significantly higher.
Those prospects have started to improve lately as China’s economy starts to recover and the US appears to have avoided a steep slowdown. But even if the signs of green shoots prove not to be a false alarm, it will be difficult for the RBA to sit on the sidelines and wait for wage growth to pick up as long as inflation stays below 2% and there are no signs of it moving higher.
This puts all the more focus on Wednesday’s CPI report as any surprises to the data would either increase or reduce market expectations of a rate cut. At the moment, traders have fully priced in a 25-bps rate cut by October. Any change in those odds would have a major impact on the AUD/USD pair in forex markets.
The Australian currency has been trading in a $0.70-$0.72 range since February and will likely remain confined to that range whilst geopolitical and economic uncertainties persist. In the near term, though, a strong set of inflation figures could propel AUD/USD above the 23.6% Fibonacci retracement level of the up leg from 0.6743 to 0.7295, at 0.7165, before attempting to take on the 0.72 level.
On the other hand, a weakening in inflationary pressures could pull AUD/USD below the 50-day moving average (MA), currently at 0.7112. Failure to hold above the 50-day MA would open the way for the 50% Fibonacci at 0.7019.
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