Australian Dollar weakens despite warnings of RBA rate hikes

Persistent inflation could require further interest rate increases, RBA Assistant Governor Sarah Hunter warned.
90.6% is the market-implied probability of unchanged Fed rates in October, according to the CME FedWatch Tool.
Middle East risks remain in focus for traders, from US-Iran tensions to Houthi attacks in Saudi Arabia.

0.7030 is the approximate level for AUD/USD in Monday’s Asian session. The pair is retreating after modest gains in the previous trading day. Its losses could be limited, however, as warnings from Reserve Bank of Australia (RBA) Assistant Governor Sarah Hunter may lend support to the Australian Dollar (AUD).

TMGM Analysis: Financial Market News, Economic Calendar & Market Insights

Stubborn inflation and the risk that imported price pressures become embedded in the economy may require additional interest rate increases, Hunter warned on Sunday. Following four rate hikes earlier this year, her comments strengthened expectations that monetary policy would remain restrictive.

September’s inflation release later this week is now the focus for markets. The data follow August CPI readings that stayed above the RBA’s 2% to 3% target range. A fresh escalation in the US-Iran conflict that lifts crude oil prices would also intensify the RBA’s concerns about second-round inflation effects. This would raise the likelihood of additional policy tightening beyond November.

Above-target inflation expectations test RBA credibility

Survey findings point to a troubling change in domestic attitudes towards inflation, according to Commerzbank’s Norman Liebke: “a growing share of businesses believe that inflation of 3-3.5% is ‘the new normal’.” Against the “long-term inflation target of 2-3%,” he sees this as a problem for the RBA’s inflation-targeting framework. The concern is already evident in the data, he stresses: “trimmed-mean inflation most recently stood at 3.6%, further above the target range.” In his assessment, elevated core inflation alongside shifting expectations compounds the policy challenge, while markets assign increasing weight to the possibility of further RBA tightening.

The forthcoming Federal Reserve policy decision is also drawing traders’ attention. Markets broadly anticipate unchanged interest rates, with another increase potentially following in December. The CME FedWatch Tool puts the market-implied probability of a pause at the October 27–28 policy meeting at 90.6%, while the chance of a December hike stands at 79.7%.

Geopolitical developments across the Middle East remain under close scrutiny. According to Al Jazeera, US President Donald Trump dismissed immediate military action against Iran, saying, “there will not be a strike today,”. Earlier, Trump had suggested that Washington might have to “finish the job” or possibly secure an agreement with Tehran, as Iranian and Houthi threats to American interests in the region increased.

Regional tensions also intensified after Yemen’s Houthis said on Sunday that attacks on Saudi Arabia’s King Khalid Airport in Riyadh would continue, Reuters reported. Only hours earlier, Saudi officials had said flights at the airport had resumed despite repeated attacks by the group.

Australian Dollar: Key Questions

Australian Dollar: The main market drivers

Interest rates set by the Reserve Bank of Australia (RBA) are among the strongest influences on the Australian Dollar (AUD). Australia’s resource-rich economy also makes the price of iron ore, its largest export, a key driver. Other influences include economic conditions in China, Australia’s largest trading partner, as well as domestic inflation, economic growth and the trade balance. Investor appetite for risk matters too. A shift towards riskier assets, known as risk-on sentiment, supports the AUD, while a preference for safe havens is described as risk-off.

RBA decisions and their effect on the Australian Dollar

By setting the interest rate at which Australian banks can lend to one another, the Reserve Bank of Australia (RBA) affects borrowing rates across the economy and, in turn, the Australian Dollar (AUD). Its primary objective is stable inflation of 2-3%, pursued through increases or reductions in interest rates. Rates that are relatively high compared with those of other major central banks support the AUD; relatively low rates have the reverse effect. Quantitative easing and tightening provide additional ways for the RBA to influence credit conditions. Easing is negative for the AUD, whereas tightening is positive.

China’s economy: Implications for the Australian Dollar

As Australia’s largest trading partner, China has a substantial influence on the Australian Dollar (AUD). A strong Chinese economy buys more Australian raw materials, goods and services, increasing demand for the currency and lifting its value. When Chinese growth falls short of expectations, the reverse applies. Surprises in China’s growth figures, whether positive or negative, therefore frequently feed directly into the Australian Dollar and its currency pairs.

Iron ore prices: A key Australian Dollar driver

At $118 billion annually, according to 2021 data, iron ore is Australia’s largest export, with China its main destination. Its price can consequently influence the Australian Dollar. Rising iron ore prices generally lift overall demand for the currency, supporting the AUD, while falling prices have the reverse effect. Higher prices also tend to increase the likelihood of an Australian trade surplus, another supportive factor for the AUD.

Trade balance: How it influences the Australian Dollar

Export earnings minus import spending determine a country’s trade balance, another influence on the Australian Dollar. Strong overseas demand for Australian exports can lift the currency when demand from foreign buyers exceeds Australia’s spending on imports. A positive net trade balance therefore supports the AUD, while a negative balance has the reverse effect.