The Reserve Bank of Australia (RBA) will conclude its latest meeting at 04:30 GMT Tuesday. Markets are split on whether the central bank will stick to its taper plans or whether it will reverse that decision as lockdowns continue. The risks surrounding the aussie from this meeting seem tilted to the downside, as even a decision to push ahead with tapering might be seen as a policy mistake.Â
Dodging a recession
The past couple of months have been tough for the Australian economy, which has been grappling with strict lockdowns to control the Delta outbreak. This will inevitably hit economic activity in the third quarter, something already evident in PMI business surveys that cratered.
On the bright side, the economy was quite strong heading into this weakness, with the unemployment rate falling substantially and GDP data for the second quarter showing solid growth. That diminishes the risk of a technical recession, which is defined as two consecutive quarters of negative growth. Of course, this assumes things will turn around in the final quarter.
That’s debatable. The government has stressed it wants to see the nation’s vaccination rate hit 70 – 80% before relaxing any restrictions. While vaccinations have been accelerating lately, that’s a difficult target to hit. Most of Europe is still around 70% while America is even lower, despite starting much earlier.
RBA reversal?Â
When the RBA last met in early August, it decided to stick to its plan to reduce asset purchases despite the lockdowns. The logic was that previous shutdowns didn’t hit the economy that hard and if things worsened further, policymakers could always change their mind.
There is no doubt things have worsened and the economy looks set to take a much bigger hit than previously anticipated. To make matters worse, iron ore prices continue to fall and China is also slowing down. This is crucial since iron ore is one of Australia’s biggest exports and China is the nation’s biggest customer for that.
So what will the RBA do this time? Admittedly, the most prudent approach would be to pause the normalization plans for now. It made sense to reduce stimulus a few months ago, but not anymore. Pushing ahead with those plans would save the RBA some face, but it would be a very questionable move from a risk management perspective as it could exacerbate the ongoing economic hit.
Market reactionÂ
As for the aussie, it is difficult to envision a scenario where the currency rallies powerfully after this meeting. Either the RBA will pause its tapering plans, sending a dovish signal that hits the aussie, or it will push ahead with normalization regardless of the worsening outlook. That may be seen as a policy mistake and therefore limit any upside in the currency.
Another middle-of-the-road solution would be for the central bank to reduce its asset purchases, but signal that it won’t cut them again for a while, at least until the economy is out of the woods. That’s a relatively neutral outcome for the FX market.
Turning to the technical picture, aussie/dollar has staged a strong comeback over the past couple of weeks, capitalizing on a softer US dollar as well. If the bulls remain in control, the next target may be the 0.7530 region.
On the flipside, if the RBA backpedals on its taper ambitions, the pair could edge back below the 0.7415 zone. If so, the focus would then turn towards the 50-day moving average, currently at 0.7374.
