AUD Market May Find Bar To Deeper Rate Cuts Very High Indeed

AUD Market May Find Bar To Deeper Rate Cuts Very High Indeed


Australian Dollar, Official Cash Rate, Talking Points:

  • Australian interest rates were cut to a new record low last week
  • Futures markets think they are going lower yet
  • They may, but deep cuts will pose big problems without offering obvious solutions

Find out what retail foreign exchange traders make of the Australian Dollar’s prospects right now at the DailyFX Sentiment Page.

The Australian Dollar rose last week after the first domestic interest rate cut since late 2016 took the Official Cash Rate down to a new record low of 1.25%.

This is counterintuitive. After all lower rates ought to count heavily against a currency. However, in the Aussie’s case the market had become extremely ‘dovish’ on interest rate policy before the fact. That means investors were certain that the delivered cut was coming. They were and remain pretty sure that rates will yet go lower still. This certainty had reached the point where the only way in which the Reserve Bank could have met it would have been by promising to cut again in July. It was never going to do this so, sure enough, it was read as ‘less dovish than the market’ and up went the currency.

Australian Dollar Vs Dollar, Daily Chart

However, Australian rate futures still price in the chance of another cut next month at more than 50%, with yet another reduction penciled in before May next year. That would take the OCR down to 0.75%.

Now on one important level this is not controversial. The RBA is mandated to target annualized consumer price inflation between two and three percent. The last read was 1.3%. Indeed, inflation has made only two, brief quarterly forays above 2% since mid-2014. Looked entirely through the prism of its mandate the case that the RBA should in fact have acted is quite easy to make. Perhaps indeed it should have acted sooner.

Don’t Forget All That Debt

But there’s at least one huge problem here for the central bank. In a word, it’s ‘debt.’ Australian private individuals are already among the developed world’s keenest borrowers. According to data from the Institute of International Finance Australian household debt equaled 127% of Gross Domestic Product at the end of last year, and 189% of disposable income. Both measures are close to record peaks and put Australia either at or very close to the top compared to similar economies.

The RBA will be keenly aware that more than two years of record low interest rates has of course stoked borrowing while not notably stimulating inflation. With too many Australians already horribly in hock, the dangers of encouraging yet more borrowing are clear enough. For its part central bank is betting much on the labor market. That has been a rare, consistent strong point in an Australian economy which remains an astonishing job-creation machine. It’s been a non-inflationary machine too, so far, but the RBA still seems to believe that eventually wage pressures will be seen in the pricing figures.

So, this week’s official labor market statistics will probably be even more notable than usual for Aussie watchers. The jobless rate is expected to have ticked lower to 5.1% in April. While it remains close to that psychologically comforting 5% level, the RBA will probably stick to its line that eventually labor will ride to inflation’s aid. The market may well get the one more rate cut it’s expecting, but action beyond that seems far less certain.

The combination of high private debt and strong job creation might make the bar to deeper cuts much higher than the market now thinks.

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Whether you’re new to trading or an old hand DailyFX has plenty of resources to help you. There’s our trading sentiment indicator which shows you live how IG clients are positioned right now. We also hold educational and analytical webinars and offer trading guides, with one specifically aimed at those new to foreign exchange markets. There’s also a Bitcoin guide. Be sure to make the most of them all. They were written by our seasoned trading experts and they’re all free.

— Written by David Cottle, DailyFX Research

Follow David on Twitter@DavidCottleFX or use the Comments section below to get in touch!





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