RBA Rate Decision (22:30 GMT; 17:30 EST)
Expected: 6.75%
Previous: 6.50%

How Will The Markets React?

Speculation is mounting that the Reserve Bank of Australia will raise rates for the second time this year to an 11-year high of 6.75 percent, helping to drive the Australian dollar higher and leading the country’s government bonds lower. In fact, interest rate swaps are pricing in a 92 percent chance of a 25bp hike while all of the 27 economists polled by Bloomberg News anticipate a rate increase. The central bank had already been perceived as remaining hawkish, but it was the most recent release of Australian inflation data that cemented prospects for a rate increase. Indeed, core consumer prices jumped by the most in 16 years during the third quarter, pushing the annual inflation rate just above the central bank's target band of 1 – 3 percent to 3.1 percent. Meanwhile, retail sales also proved to be stronger than expected in September and for the entire third quarter, suggesting that domestic demand could be sparking additional price pressures. While it appears that the central bank has enough fundamental support to raise interest rates, there could be political ramifications as the decision comes less than three weeks before the national elections, in which Prime Minister John Howard will be seeking a fifth term in office. Recent commentary from Howard shows that he is trying to shield himself from negative press based on the rate hike as he said, “My argument, to the Australian people, will be we are entering a slightly more challenging phase of economic management. And that is not the time to substitute a very experienced, successful government when it comes to economic management with a group of people who will be very inexperienced.” Clearly, there is quite a bit riding on the RBA’s rate decision, but they are unlikely to pull any surprises and traders should prepare for tighter monetary policy in Australia.

Bonds – 10-Year Australian Government Bond Futures

Australian government bond futures have held tightly within their recent range, with price likely to break out in the near-term. The release of the RBA’s rate decision could ignite this price action, as an increase will likely send the contract back down towards 93.655. On the other hand, if the RBA surprises the markets and leaves rates steady, Australian government bond futures may surge up to the 93.90 level.

FX – AUD/USD

The uptrend for AUD/USD remains very much intact, especially as the greenback remains broadly weak and COT positioning suggests that no turn is in store for the pair. This week’s event risk should remain supportive of the Aussie as well, since the RBA is widely anticipated to hike rates 25bp to an 11-year high of 6.75 percent. With carry trades remaining bid, AUD/USD could take on the 23-year highs at 0.9343 once again on the news. However, if the RBA unexpectedly leaves rates steady or notes a very neutral bias in their policy statement – signaling that additional rate increases are unlikely – AUD/USD may actually start to pull back towards trendline support near 0.9000. 

Equities – S&P/ASX 200 Index

Compared to equities in the US, Australian shares have held up somewhat better as the S&P/ASX bounced from support at 6,550 on Tuesday. However, traders should watch for event risk from the RBA rate decision. While financial shares have been faring well amidst speculation that the country’s banks are shielded from the broader issues plaguing large institutions like Citigroup, a rate hike to 6.75 percent could send the S&P/ASX plummeting at least to support at 6,550. On the other hand, if the RBA surprises and leaves the benchmark lending rate unchanged, the equity index is likely to rally through 6,700.

Terri Belkas is a Currency Strategist at FXCM.