I wanted to send out an e-mail to everyone and give them my input on the unexpected strength the AUD found on the CPI release last night.
I tend to spend more time researching a trade that went wrong than I do on a trade that went right. Fortunately, last night’s trade on the AUD did not hit our triggers so it was a no trade but it still poses the question: "What happened?"
The third quarter core inflation data was released at the same time as the CPI and the inflation data was extremely positive. The reason that this inflation data is so important is that past Reserve Bank of Australia (RBA) rate hikes have had a close correlation with CPI releases. With 13 of the 14 rate hikes over the past decade being announced either after the board meeting in the same month as CPI figures or in the month immediately following a post CPI rate hike.Seasonal influences associated with health and pharmaceutical processes are expected to slow down inflation.
Some analysts suggest that current growth seen in Australia’s economy isn’t inflationary. The economy is clearly firm. Food prices have risen and unemployment is falling. But, with population growth at 17-year highs and productivity firmer, the speed limit of the economy has nudged up, suggesting that the current pace of growth possesses less threat to inflation.Inflation outlook: Oil prices have jumped 27% over the past two months. The persistent drought could lead to more food inflation, and both factors will be taken into account by the RBA when they meet.
Retail Sales data for August showed very strong food prices inflation, suggesting that inflation could accelerate in the fourth quarter. The consensus is that with a further acceleration in domestic activity beyond production capacity in the second half of 2007, and the topping out of the currency, inflation will threaten the top of the RBA’s target band in the first quarter of 2008.
This will see policy expectations remaining hawkish. Recent data has also shown that Aussie consumers expect inflation to accelerate over the next year. Clerks and sales people had the highest medium inflationary expectations of 5.7%, far above the RBA’s target band of 2% to 3%. In the actual release, the RBA stated that the core inflation is what matters, not the headline CPI measure, which in any case was biased down by childcare rebates, and thus artificially low.
Given the pattern of the past 18 months, this high underlying reading effectively sets the seal on a rate hike at the RBA’s next meeting in November. The more important question now is how much further will they have to go past that. We could see the market price in a second and even a third hike. It’s almost a foregone conclusion for a rate hike on November 7th.
The way it looks at the moment, non-farm GDP is growing at 5.2% year on year and inflation has accelerated from quarter two to quarter three so it doesn’t look like the economy is about slow down, particularly not with all the giveaways in the election. So I think it’s going to be very easy to justify a rate hike and quite tricky to justify not raising rates. Personally, I think that the RBA will raise rates by 25 basis points on November 7th and also maintain a tightening bias given the strength of the economy, the higher inflation outlook and also taking into account spending during the election campaign which will continue to spur the domestic demand in 2008 and beyond.
To summarize, the move that occurred was triggered by data that would support an almost imminent rate hike. In addition the RBA has changed there focus from the headline CPI to the core inflation going forward which came out positive for the AUD. I must say we learn the most from losses and near losses. Fortunately we did not get a safe trigger, so in this case we learn from our near losses.
