The Reserve Bank of Australia Opted for a Smaller Rate Hike, but Pointed to More Moves Ahead

Conservative Hike

The Reserve Bank of Australia (RBA) raised interest rates by 25 basis points today ^[1], adjusting the cash rate target to 2.6% and nine year highs. This was the sixth consecutive hike, but it was also smaller than expected and than the 50 bps increases on each of the previous four meetings.

Despite being conservative, today's move did not come as a surprise, as officials have hinted towards a lees aggressive path, given the frontloaded and lagging nature of the tightening process that began in May. The RBA alluded to this, as it attributed the smaller hike to the fact that the cash rate "has been increased substantially in a short period of time".

The central bank had tweaked its policy statements of the previous two meetings, towards a conservative direction, cautioning that that policy is "not on pre-set path". More to it, Governor Lowe had recognized last month that "the case for a slower pace of increase in interest rates becomes stronger as the level of the cash rate rises". ^[2]

More Tightening Ahead

Even though it opted for a conservative move, the Reserve Bank of Australia remains on a hawkish path, having delivered 250 basis points worth of rate hikes in around half a year. Furthermore, policy makers expect "to increase interest rates further over the period ahead" and reiterated their commitment "to returning inflation to the 2–3 per cent range over time".

Today's underwhelming move was reasonable, but officials will probably have a hard time pausing, while expecting a "further increase in inflation", from the 6.1% print of the headline Consumer Price Index in Q2 (year-over-year).

Moreover the labor market is still "very tight" as per the bank's assessment and the Unemployment Rate remains around the lowest levels in half a century, after ticking-up to 3.5% in August. The Board also judged that the Australian economy "is continuing to grow solidly", with the Gross Domestic Product (GDP) having expanded by a respectable 3.6% in Q2 year-over-year.

The above factors give the RBA the luxury to stay on its tightening path and assess the impact on the economy without heightened urgency, unlike other central banks that have a much more difficult task.

Policy Differential

The Reserve Bank of Australia took a step back today and remains to be seen whether other central banks will follow. The US Federal Reserve is probably the most hawkish one, since it raised rates to fourteen-year highs and remains totally committed to bringing inflation down to its 2% target.

Officials raised their rate forecasts in September, they have repeatedly touted their singular focus on restoring price stability and they seem to have given up a soft landing. Chair Powell said after the last meeting that no one knows if the current tightening "will lead to a recession and if so how significant that recession would be". ^[3]

This strategy however, has reignited fears of a recession and we have recently seen a moderation in market expectations around the Fed's next moves. At the time of writing, CME's FedWatch Tool still projects a 75 bps hike in November, but with lower sub-60% probability, whereas for December the highest probability of 48% is assigned to minuscule 25 bps adjustment. ^[4]

AUD/USD Reaction

The Aussie initially reacted lower to the smaller than expected hike by the Australian central bank, but the US Dollar continues its recent slide due to the market repricing around the Fed's hike-cycle.

As such, AUD/USD extends yesterday's gains during the European hours and its rebound from last week's 2+ years low (0.6362), challenging the 38.2% Fibonacci of the September high/low drop.