China's central bank surprised markets by raising its benchmark interest rate in European trading Tuesday, which caused a short term move in favor of the USD. The news hurt the Australian Dollar as its export led growth is fed by China's appetite for its raw materials like coal and iron ore.

The Chinese authorities increased their benchmark rate by 25 basis points, bringing the one-year lending rate to 6.06% from 5.81%, and boosting the one-year deposit rate to 3% from 2.75%. A higher deposit rate means that Chinese households and institutions will encourage savings, while a higher lending rate means its more expensive to borrow. It's the 3rd hike since October of last year and more may have to come to stem the recent surge in inflation.

It was the final day of a week-long Chinese holiday for Chinese New Year, and comes about a week before data on consumer prices that is likely to show the annual CPI climbing to 5.3%.

The rate increase was not completely unexpected as China has been waging an aggressive campaign of late to try and tackle its elevated inflation. Such steps by China - raising rates and bank reserve requirement ratios - will undoubtedly slow the fastest-growing major economy and that will feed through to less demand for higher yielding but also riskier assets. At the same though, China is raising rates from a position of strength, and still has solid growth momentum (4th quarter annual growth was near 10%) which means more will have to be done by Chinese officials.

Aussie Recedes Following China's Rate Hike

The AUD/USD fell from its highs near 1.0190 - which was close to our pivot from last week. The news also impacted commodity prices like oil and copper which fell, and we saw selling in emerging market equities.

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How strong the impact on commodity prices is from this development will tell us if the AUD/USD moves below its recent support at the 1.01 area.

The AUD/JPY, which had been in a strong uptrend during the past 6 sessions, topped off at yesterday's highs at 83.70 and declined. We'll see if this means a further retracement of the 270 pip rally.

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If we continue to decline in this pair, look for the 82.55 pivot as a target/next support pivot to the downside.

Now interestingly enough, the EUR/USD was not affected much by this release and actually extended its rally from earlier European trading following the news.