July Rate Expectations: No Moves Expect for ECB in 2011

The latest economic developments have caused investors to push out their rate expectations for all of the major central banks. In May, the ECB, BoC and RBA were all expected to raise rates before the end of the year and now aside from the ECB no one is expected to tighten. Rate expectations are always changing and a lot has happened over the past month. It is always important to keep track of them because they reflect what investors are pricing in!

Here are the latest numbers and highlights (compared to May – click to enlarge)

Fed – One 25bp rate hike expected by Q2 2012
ECB – 50bp of additional tightening expected by end of year
BoE – First Rate hike expected in May > compared to prior forecast for 25bp rate hike in Jan
RBA – No rate hike within the next year – major downgrade from past expectations
RBNZ – One rate hike in March 2012 > pushed out from Jan 2012
BoC – 25bp rate hike in Feb > pushed out from Oct

What Now for the AUD?

Last night, the Reserve Bank of Australia left interest rates unchanged at 4.75 percent. Many investors were looking for hawkish comments from the central bank but as suspected, the RBA failed to deliver. Given the recent deterioration in economic data (that we showed in our Australian Data Table), I was a bit surprised by the market’s lofty expectations. Of the 28 economists surveyed by Bloomberg, 5 even expected a rate hike! However the RBA proved to not be as carelessly hawkish as I had feared by maintaining a neutral to slightly optimistic tone. Much of the RBA statement remained unchanged from the previous month which suggests that the central bank has not grown any more hawkish or dovish. As a result, investors sold the Australian dollar, making it the only high yielding currency to NOT appreciate against the greenback today.

However just because the RBA opted for a more neutral stance does not mean that the rally in the AUD/USD is over. Based upon the central bank’s positive comments on growth, terms of trade, private investment and national income, interest rates could still be increased before the end of the year. The RBA is just waiting for commodity prices to resume its rise or the U.S. and China to experience stronger growth. As a result, the Australian dollar should continue to outperform the greenback. Even if the RBA maintains its current stance for the rest of the year, the AUD/USD could still trend higher simply on the easy monetary policy in the U.S.

Technically, the following chart shows that the AUD/USD is prime for a breakout. If the currency pair breaches 1.08, it should be clear sailing towards 1.10.

RBA Meeting: Don’t Rule Out a Disappointment

It is going to be a busy night in Australia with the Reserve Bank gearing up for its next monetary policy announcement. The last time the RBA met was on May 3rd and at the time, the central bank left rates unchanged even though they expected inflation to rise because they felt the strong Aussie would help to hold prices down. However given the trend of inflation and the central bank’s rosy outlook for growth, “rates will need to be increased at some point” according to the RBA. The only question is, how quickly will the RBA act?

Based upon how the economy has performed since the last monetary policy announcement, there should be no urgency within the RBA to raise interest rates. Service and manufacturing activity slowed materially in May while inflation expectations and consumer confidence declined. GDP numbers for the first quarter showed growth contracting by 1.2 percent, which was the steepest decline in 20 years. The table below shows how the Australian economy has deteriorated since the last RBA meeting and yet many people expect the RBA to be hawkish with a minority even calling for a 25bp rate hike this evening.

Why in the world would economists be so optimistic given the deterioration in the Australian economy – the reason is because continued demand for Australian products has helped to boost the terms of trade while investment demand remains solid. The sharp pull back in the first quarter only means a stronger rebound in the second according to market watchers. Although recent comments from the RBA suggests that the central bank is optimistic about the outlook for the local economy, we would not rule out the possibility of more cautious comments given the disappointments in economic data and the strength of the Aussie.