Yesterday we laid out the key fundamental themes that will be driving the AUD this week and key on that list was what we would hear from the Reserve Bank of Australia following its interest rate meeting. As was widely expected the central bank did not raise interest rates, and in its statement it did not give clues that a rate hike would be coming any time soon.
Inflation was expected to remain within the RBA range of 2-3% throughout the year.
From the RBA statement, here's the takeaway paragraph: Inflation is consistent with the medium-term objective of monetary policy, having declined significantly from its peak in 2008. These moderate outcomes are being assisted by the high level of the exchange rate, the earlier decline in wages growth and strong competition in some key markets, which have worked to offset large rises in utilities prices. Production losses due to weather are temporarily raising prices for some agricultural produce, but these should fall back later in the year. Overall, looking through these temporary effects, the Bank expects that inflation over the year ahead will continue to be consistent with the 2-3 per cent target.
At today's meeting, the Board judged that the current mildly restrictive stance of monetary policy remained appropriate in view of the general macroeconomic outlook.
Let's address some of the statistics behind this statement. It's true that inflation has eased recently. The Consumer Price Index rose a weaker than expected 0.4% in the 4th quarter (0.7% in Q3 2010), while the annual rate came in at 2.7% (3.0% was the median forecast and annual CPI was 2.8% in Q3 2010). The TDMI Inflation Gauge meanwhile was up 0.2% in in February, weaker than the 0.4% pace in January. If inflation remains subdued, and below the upper part of the RBA' target of 3%, then the RBA has scope to remain on the sidelines.
Australia's benchmark interest rate of 4.75% is currently the highest in the developed world. RBA Governor Glenn Stevens recently told lawmakers we're ahead of the game, which is where you want to be, and that's the thing that affords you periods of sitting, waiting and watching. Sometimes, they can be reasonably lengthy periods.
This tells us that the RBA will remain on the sidelines for the time being even as the labor market hits full employment at 5%, usually a trigger for higher inflation. Markets are currently looking for a rate hike in May.
Stevens expects inflation to be contained on the back of a stronger Aussie - which makes imports to Australia cheaper - as well as an earlier decline in wage growth will contain inflation. Recently, a report on wages showed labor costs up 3.9% in the Q4 2010 compared to a year ago, which was the fastest pace since Q1 2009. Will higher wages transform to more spending thereby putting another upward pressure on prices? That remains to be seen.
In data overnight we saw that retail sales were up 0.4% in January, compared to the median forecast of a 0.3% gain, and following a soft 0.2% increase in December.
The AUD/USD rose overnight, but was beaten back at the 1.02 level. This level has acted as strong resistance last time we tested it in February. The fact that the RBA seems content with rates and inflation at there current levels could undermine the AUD as it tries to break through this important barrier.
We know look forward to Australian GDP data and trade statistics the rest of the week. If they come in stronger than expected that could give the AUD the boost it needs. However, We have another strong level of resistance at our all-time high near 1.0250.