AUD/USD: Trading the Reserve Bank of Australia Interest Rate Decision

Trading the News: Reserve Bank of Australia Interest Rate Decision

What's Expected:

Time of release: 05/03/2011 4:30 GMT, 0:30 EST

Primary Pair Impact:AUDUSD

Expected: 4.75%

Previous: 4.75%

DailyFX Forecast: 4.75%

Why Is This Event Important:

Although the Reserve Bank of Australia is widely expected to hold the benchmark interest rate at 4.75% in May, the central bank may strike a hawkish tone for future policy as price pressures intensify, and the statement accompanying the rate decision could push the AUD/USD to a fresh record high as currency traders expect to see higher borrowing costs over the coming months. According to Credit Suisse overnight index swaps, market participants are pricing a zero percent chance for a rate hike this time around, but see the interest rate increasing by at least 25bp over the next 12-months as growth and inflation accelerate. However, as the region copes with the natural disasters that ravaged throughout the region, the central bank may retail a neutral tone going into the second-half of the year, and the aussie-dollar may consolidate in the days ahead as it remains heavily overbought.

Recent Economic Developments

The Upside

The Downside

As the headline reading for inflation expands at the fastest since the fourth-quarter of 2008, the ongoing improvement in the real economy could lead the RBA to raise its assessment for growth and inflation, and the central bank may highlight an increased willingness to tighten monetary policy further as it aims to balance the risks for the region. However, as the expansion in global trade cools, the ongoing slack within the private sector could lead the RBA to retain its current policy stance over the coming months, and demands for the Australian dollar may subside over the near-term as interest rate expectations wane. In turn, the marked rally in the AUD/USD may taper off going into May, and a neutral statement from the central bank could certainly spur a near-term correction in the exchange rate as it remains at record-high levels.

Potential Price Targets For The Rate Decision

How To Trade This Event Risk

With the RBA widely expected to maintain its current policy in May, attempting to trade the rate decision is certainly not as clear cut as some of our previous recommendations, but the statement accompanying the announcement could set the stage for a long aussie trade if we see the central bank toughen its stance against inflation. Therefore, if the RBA adopt a hawkish outlook for monetary policy, we will need a green, five-minute candle following the event to generate a buy entry on two-lots of AUD/USD. Once these conditions are met, we will set the initial stop at the nearby swing low or a reasonable distance after taking market volatility into account, and this risk will establish our first objective. The second target will be based on discretion, and we will move the stop on the second lot to cost once the first trade reaches its mark in an effort to preserve our profits.

In contrast, the uncertainties surrounding the economic outlook paired with the ongoing weakness within the housing market could lead the RBA to uphold its current policy going into the second-half of the year, and the RBA may talk down speculation for higher borrowing costs as the marked appreciation in the local currency dampens the outlook for future growth. As a result, if the central bank continues to look past the rise in inflation and sees price growth moderating over the coming month, we will carry out the same setup for a short aussie-dollar trade as the short position mentioned above, just in reverse.

Impact that the RBA Interest Rate Decision has had on AUD during the last meeting

April 2011 Reserve Bank of Australia Interest Rate Decision

The Reserve Bank of Australia held the benchmark interest rate at 4.75% for the fourth-time in April, noted that the ‘mildly restrictive' policy remains appropriate as it aims to curb the risk for inflation, and the central bank may retain its wait-and-see approach throughout the first-half of the year as the outlook for global growth remains clouded with high uncertainty. However, the RBA held a mixed outlook in the policy meeting minutes as the central bank expected inflation to remain ‘quite high' in the first quarter, while economic activity is likely to be ‘held down,' by the natural disasters that ravaged through the region, and went onto say that the board will ‘look through these fluctuations' as the central bank expects the rebuilding efforts to strengthen the recovery in the second-half of the year. The neutral tone held by the central bank initially sparked a bearish Australian dollar retraction, with the exchange rate slipping to 1.0312, but the decline was certainly short-lived as the AUD/USD ended the day at 1.0328.

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To discuss this report contact David Song, Currency Analyst: dsong@dailyfx.com