ECB to Leave Rates Unchanged for Rest of the Yr? RBA to Cut?

Even though ECB President Trichet was quite clear last week in signaling that rate hikes are not over, based upon interest rate futures, investors are actually pricing in NO RATE HIKES for the rest of the year and into the first half of 2012.

Since the beginning of the year, the ECB insisted that the sovereign debt crisis would not affect their monetary policy decisions which are made based exclusively on the levels of inflation but investors believe that the crisis cannot be ignored.

The other major changes are the following:

RBA – Market now expects a Rate Cut in October
FED – No rate hikes expected before the second half of 2012
BOE – No rate hikes expected before the second half of 2012
RBNZ – First rate hike pushed out from Jan to March
BoC – First rate hike pushed out from Feb to April

Here are the details:

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.