Special FX Reports – RBA meeting Tuesday, a 25bps hike is expected

Here are the latest Financial News:

The Reserve Bank of Australia, (RBA) will hold a monetary policy meeting on Tuesday, February 2nd. The RBA policy announcement is expected at 00.30 GMT. The consensus is the RBA will hike rates 25bps to 4%. The RBA is also expected to signal a pause in its tightening cycle as domestic growth slows. The RBA decision to hike rates is a close call because recent economic data from Australia has been mixed and there is increased uncertainty about the global recovery as China tightens monetary policy. Monday, Australia reported a strong 5.2% rise in Q4 house price index and higher consumer prices in January with TD/Melbourne Institute inflation index rising by 0.8%. Australia also reported a sharp 4.6% decline in December home sales and weaker jobs ads. December job ads declined by 8.1% in January. These reports suggest that the domestic economy may be slowing and inflationary pressures building.

The recent tightening of monetary from China contributes to weaker commodity and global equity market trade and diminished demand for high yield commodity linked currencies like the AUD. The AUD traded near a one month low Monday. The RBA hiked rates 25bps three consecutive times since October. The rate hikes came as the RBA board members concluded that worse for the global recession had past and the Australian domestic economy weathered the downturn. In the December policy statement the RBA said that they expect growth in 2010 to be close to trend and inflation near target. Australian yields remain near historic lows. The recent string of rate hikes is not that dramatic. Rate hikes are thought to have a four month time lag before impacting the economy. Uncertainty about the global recovery and assessing the impact of higher rate hikes will likely encourage the RBA to take a wait and see attitude towards future rate hikes.

The AUD benefited from prior RBA rate hikes supported by widening yield differential and improving risk sentiment. Recently the AUD has been weakening tracking weaker equity markets and a decline in commodity prices. Investors may elect to sell the AUD after the RBA policy meeting because the 25 bps rate hike has been discounted. The impact of the rate hike may be negative for the AUD as focus shifts to concern about uncertain global recovery outlook and speculators look to take profits in the AUD. If the RBA signals a pause in its rate hike cycle focus will shift towards rate outlook in the US.  Strong US Q4 GDP and ISM manufacturing contributes to higher US yields and may encourage speculation of an earlier Fed rate hike. This would begin to reduce Australia’s yield advantage and make the direction of commodities and global equities of greater importance to the direction of the AUD. Australia’s December inflation rose by 0.5%m/m and 2.1% y/y. RBA inflation target is 2 to 3%. Australia’s unemployment rate declined to 5.5% in December and jobs growth has exceeded expectations. The rise in Australia’s December inflation coupled with strong employment growth leads us to conclude that the RBA will hike rates 25bps at Tuesday’s policy meeting.

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