The Reserve Bank of Australia is due to announce its next policy decision on Tuesday at 0430 GMT and is widely expected to keep interest rates unchanged, pausing after two consecutive cuts. However, with the Australian dollar coming under heavy selling pressure over the past week, its clear investors are anticipating more reductions in the months ahead. Hence, the language in the RBA’s statement will be carefully examined for clues about the likely scale of future cuts.
RBA to pause after two cuts
Australia’s central bank, along with the Reserve Bank of New Zealand, have taken the lead in the latest global easing cycle. The RBA has so far cut the most, lowering its cash rate by 50 basis points to a new record low of 1.00%. But as rates approach the zero level, policymakers will likely want to pause a bit before using up their remaining ammunition as they assess how the economy evolves over the coming months.
Like much of the rest of the world, Australia’s economy is being weighed down by the ongoing trade conflict between China and the United States. China is Australia’s largest market for exports so a slowdown there has a notable impact on Australian industries as well as on business confidence. However, so far, there’s been little or no impact on Australian mining exports as demand from China has withstood the fallout from the trade war and the price of Australia’s biggest export – iron ore – has soared to the highest in more than five years, boosting the country’s terms of trade and the government’s tax intake.
Weak consumption a drag on growth
In fact, the biggest worry for policymakers has been sluggish domestic consumption, which is being held back by muted wage growth and falling house prices. The RBA had been hoping that a tightening labour market would eventually push up wage increases. But growth in full-time employment has been soft in recent months and the unemployment rate has been edging higher, pointing to plenty of spare capacity still in the labour market.
This leaves the RBA with little option but to become more accommodative to stimulate the domestic economy. With inflation currently stuck below the RBA’s target band of 2-3%, the Bank can afford to loosen policy further. Data released in the past week showed the annual rate of CPI unexpectedly jumped from 1.3% to 1.6% in the second quarter. But this is unlikely to stop the RBA from cutting rates further, especially as underlying inflation also remains well below the target.
Aussie slumps to 6-week lows
Expectations of more stimulus have driven the Australian dollar to six-week lows against its US counterpart, though some unwinding of the aggressive bets of Fed easing has also contributed to the aussie’s decline versus the greenback. If the RBA maintains a strong easing bias on Tuesday, the local dollar could extend its losses, potentially eying the 2019 low of $0.6743, which is near the 200% Fibonacci extension of the July upleg. A breach of this support region would open the way for deeper losses as far as the 261.8% Fibonacci at $0.6624.
Should the RBA surprise, however, by not committing to future rate cuts, the aussie could be in line for a sharp rebound given its current oversold technical status. The aussie could initially recover around the $0.6830 area before aiming for the $0.69 handle.
Will RBA signal more cuts?
One possible factor why the RBA may decide to tread carefully when it comes to additional rate reductions is that it may want to wait and see what the impact of its existing measures will be on the economy as well as the potential boost from the recently announced tax cuts by the government. Markets have fully priced in one more 25bps cut before the year end so any big adjustment to those odds would lead to significant moves in the aussie.
